1 - Overview of Accounting

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 Review
• Accounting involves the activities of identifying,
measuring, and communicating information that
is useful in making economic decisions.
• Recognition refers to the process of incorporating
the effects of an accountable event in the
financial statements through a journal entry.
• External events are events which involve an
entity and another external party. It includes (a)
exchanges, (b) non-reciprocal transfers, and (c)
external events and other transfers.
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 Review
• Internal events are events which do not
involve an external party. It includes (a)
production and (b) casualties.
• Measuring is the accounting process of
assigning numbers, commonly in monetary
terms, to the economic transactions and
events. Several measurement bases are used
in preparing financial statements.

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 Review
• Financial Accounting is the branch of
accounting that focuses on the general
purpose financial statements.
• General purpose financial statement are
those that cater to the common needs of a
wide range of external users.
• External users are those who do not have the
authority financial reports tailored to their
specific needs.

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 Review
• The four sectors in the practice of
accountancy are: (a) public practice, (b)
commerce and industry, (c) academe, and (d)
government.
• The accounting standards used in the
Philippines are the PFRSs, which are based on
the IFRSs. The PFRSs comprise the following:
(1) PFRSs, (2) PASs, and (3) Interpretations.

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 Review
• The Financial Reporting Standards Council
(FSRC) is the official accounting setting body in
the Philippines.
• Financial reporting standards continuously
change primarily in response to users’ needs.

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Quiz - 1

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2 - Conceptual Framework for Financial Reporting

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Learning Objectives

• State the basic purpose, authoritative

status, and scope of the Conceptual
Framework.
• State the objective of financial reporting.
• Identify the primary users of financial
statements.
• Explain briefly the qualitative
characteristics of useful information and
how they are applied in financial reporting.
• Define the elements of financial
statements and state their recognition
criteria.
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 Conceptual Framework for Financial
Reporting
• The Conceptual Framework sets out the concepts that
underlie the preparation and presentation of financial
statements for external users.
• The FSRC’s Conceptual Framework for Financial Reporting is
based on IASB’s Conceptual Framework for Financial
Reporting, which serves as a guide to the IASB in developing
and reviewing accounting standards and in resolving
accounting issues not addressed directly in existing Standards.
• The IASB recognizes that he financial statement may differ
from country to country. The IASN aims to narrow these
differences by seeking to harmonize regulations and
accounting standards.

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 Purpose of the Philippine Conceptual
Framework
a. Assists the FSRC in developing accounting standards and in
reviewing and adopting existing IFRSs;
b. Assist preparers of financial statement in applying the
Standards and in dealing with topics that have yet to form
the subject of an FRSC Standard;
c. Assist auditors in forming an opinion as to whether financial
statements conform with Standards;
d. Assist users of financial statement in interpreting the
information contained in financial statements; and
e. Provide those who are interested in the work of FSRC with
information about its approach to the formulation of the
Standards.

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 Authoritative Status and Applicability

• The Conceptual Framework is not a PFRS. When there is a conflict

between the Conceptual Framework and a PFRS, the PFRS will
prevail.
• In the absence of a standard, management shall consider the
Conceptual Framework in making its judgment in developing and
applying an accounting policy that results in information that is
relevant and reliable.
• The Conceptual Framework is concerned with general-purpose
financial statements.

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 Authoritative Status and Applicability

1. PFRSs
2. Judgment
When making judgment:
 Management shall consider the following:
a. Requirements in other PFRSs dealing with similar
transactions
b. Conceptual Framework
Management may consider the following:
a. Pronouncements issued by other standard-setting
bodies
b. Other accounting literature and industry practices
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 Scope of Conceptual Framework
a. Objective of financial reporting
b. Qualitative characteristics of useful
information
c. Definition, recognition and measurement of
financial statement elements; and
d. Concept of Capital and capital maintenance

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 Objective of general purpose financial
reporting
• 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 about providing resources to the entity. A
secondary objective of financial statements is to show the results of
the stewardship of management.

• The objective of general purpose financial reporting forms the

foundation of the Conceptual Framework. Other aspects of the
Conceptual Framework flow logically from the objective.

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Objective of general purpose financial
reporting
Users and their Needs:
• Primary users – those to whom general
purpose financial reports are directed:
(a) Existing and potential investors
(b) Lenders and other creditors.

• Only the common needs of primary users are

met by the financial statements.
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Objective of general purpose financial
reporting
• General purpose financial statements reports
provide information n a reporting entity’s:
a. Financial position – economic resources (assets) and
claims (liabilities and equity)
b. Changes in economic resources and claims –
financial performance and other transactions and
events lead to changes in financial position
• Collectively, all these information are referred to
under the conceptual Framework as the
economic phenomena

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Objective of general purpose financial
reporting
• Economic resources and claims:
a. Financial strengths and weaknesses
b. Liquidity and solvency
c. Needs for additional financing and how successful it is
likely to be in obtaining that financing
• Primary users’ decision are based on the assessment
of an entity’s prospects for future net cash inflows. To
make this assessment, all information regarding an
entity’s financial position, financial performance, cash
flows, and other changes in financial position must be
considered.

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 Qualitative Characteristics
I. Fundamental qualitative characteristics
(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance

(2) Faithful representation

(a) Completeness
(b) Neutrality
(c) Free from error
II. Enhancing qualitative characteristics
(3) Comparability
(4) Verifiability
(5) Timeliness
(6) Understandability

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 Fundamental Qualitative
Characteristics
1. Relevance – information is relevant if its is
capable of making a difference in decisions
made by users.
a. Predictive value – the information can be used to
make predictions
b. Confirmatory value (feedback value) – the
information can be used in confirming previous
predictions
 Materiality – information is material if omitting,
misstating or obscuring it could reasonably
expected to influence decisions.
- entity-specific aspect of relevance
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 Fundamental Qualitative
Characteristics
2. Faithful representation – information provides a
true, correct and complete depiction of what it
purports to represent
a. Completeness – all information necessary for users
to understand the phenomenon being depicted are
provided
b. Neutrality – information is selected or presented
without bias
c. Free from error – does not mean that the
information is perfectly accurate in all respects but
no errors in the description and in the process by
which the information is selected and applied

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Enhancing Qualitative Characteristics
1. Comparability – information is comparable if it
helps users identify similarities and differences
between one information and another
information that is either provided by the same
entity but in another period (intra-
comparability) or by other entities (inter-
comparability).
 Consistency – refers to the use of the same
methods for the same items.
 Comparability is the goal while consistency is
the means of achieving that goal.

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Enhancing Qualitative Characteristics
2. Verifiability – information is verifiable if
different users could reach an agreement as
to what the information purports to
represent.
 Direct verification – direct observation
 Indirect verification – recalculating using the
same formula

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Enhancing Qualitative Characteristics
3. Timeliness – information s timely if it is
available to users in time to be able to
influence their decisions
4. Understandability – information is
understandable if it is presented in a clear
and concise manner

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 Applying Qualitative Characteristics
 Fundamental qualitative characteristics –
information must be relevant and faithfully
represented for it to be useful
 Enhancing qualitative characteristics –
enhance the usefulness of the information
that is both relevant and faithfully
represented but cannot make information
that is irrelevant or erroneous to be useful

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 Applying Qualitative Characteristics
 The Cost Constraint – optimum balance
between costs and benefits is desirable such
that costs do not outweigh the benefits
 Underlying assumptions – going concern or
the entity has neither the intention nor the
need to end it operations in the foreseeable
future

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 Elements of Financial Statements
Financial Position
1. Asset - resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity
2. Liability - present obligation of the entity arising from past
events, the settlement of which is expected to result in an
outflow from the entity of resources embodying economic
benefits.
3. Equity – assets less liabilities

Performance
1. Income – encompasses both (a) revenues and (b) gains
2. Expense – encompasses both (b) expenses and (losses)

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 Elements of Financial Statements
Essential elements in the definition of asset
1. Control –means that the entity has the exclusive
right over the benefits of an asset or the ability
to prevent others from accessing those benefits
(ownership & possession)
 Substance over form – considers the substance of
the transaction rather than merely its legal form
2. Past events – the control over the resource have
resulted from a past event or transaction

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 Elements of Financial Statements
Essential elements in the definition of asset
3. Future economic benefits – “future” means the
resource is expected to provide future economic
benefits over more than one accounting period
and ”economic benefits” means the potential of
the resource to provide the entity, directly or
indirectly, with cash and cash equivalent.
 Potential may be productivity, convertibility into cash
or cash equivalents or the capability to reduce cash
outflows

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 Elements of Financial Statements
Essential elements in the definition of liability
1. Present obligation arising from past events –
means that at the reporting date, the entity has
the responsibility to perform some act because
of an obligating event that has already
transcribed
a. Legal obligation – results from contract, legislation or
other operation of law
b. Constructive obligation - results from an entity’s
actions that create a valid expectation from others
that the entity will accept and discharge certain
responsibilities

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 Elements of Financial Statements
Essential elements in the definition of liability
2. Outflow of economic benefits – settling an
obligation normally requires the entity to:
a. Pay cash
b. Transfer other non-cash assets
c. Render a service
d. Replace the obligation with another obligation
e. Convert the obligation to equity

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 Recognition
• Recognition –the process of incorporating in the balance sheet or
income statement an item that meets the definition of an element and
satisfies the recognition criteria.

• An item is recognized if all of the following are satisfied:

a. The item meets the definition of an element;
b. It is probable that any future economic benefit associated with the
item will flow to or from the entity; and
c. The item has a cost or value that can be measured with reliability.

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 Expense Recognition Principles
1. Direct association or matching – cost that are directly
related to the earning of revenue are recognized as
expenses in the same period the related revenue is
recognized
2. Systematic and rational allocation – cost that are not
directly related to the earning of revenue are initially
recognized as assets and recognized as expenses over
the periods their economic benefits are consumed,
using the same method or allocation
3. Immediate recognition – cost that do not provide or
cease to provide future economic benefits are expensed
immediately

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 Measurement bases
Measurement – is the process of determining the monetary amounts
at which he elements of the financial statements are to be
recognized and carried in the balance sheet and income
statement.
a. Historical cost
 Asset - cash paid or the fair value of the consideration given
 Liabilities - the amount of proceeds received in the exchange of an
obligation or the amount of cash expected to be paid to settle the
liability
b. Current cost
 Asset - amount of cash that would have to be paid if the same asset
was acquired currently
 Liabilities – undiscounted amount of cash that would be required to
settle the obligation currently

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 Measurement bases
c. Realizable value (Settlement value)
 Assets – amount of cash that could currently be obtained by selling
the asset in an orderly disposal
 Liabilities – settlement value or the undiscounted amount of cash
expected to be paid to satisfy the liabilities in the normal course of
business
d. Present value
 Assets – discounted value of the future net cash inflows expected to
be derived from the asset
 Liabilities – discounted value of the future net cash outflows
expected to be paid to settle the liability

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 Concepts of Capital and Capital
Maintenance
• Financial concept of capital – capital is regarded as the
invested money or invested purchasing power. Capital is
synonymous with equity or net assets.

• Physical concept of capital – capital is regarded as the entity’s

productive capacity, e.g., units of output per day.

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Homework

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 True or False
1. All changes in an entity’s economic resources
and claims to those resources result from the
entity’s financial performance.
2. The qualitative characteristics of useful
information apply only to the financial
information provided in the financial
statements.
3. According to IFRS practice Statement 2 making
materiality Judgments, cost is an important
consideration when making materiality
judgments.

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 True or False
4. When making materiality judgments, a quantitative
assessment alone is not always sufficient to conclude
that an item of information is not material. The entity
should further assess the presence of qualitative
factors.
5. Materiality judgments apply only to items that are
recognized but not to those that are unrecognized
6. The more significant the qualitative factors, the lower
the quantitative thresholds will be. Thus, an item
with a zero amount can be material in light of
qualitative thresholds.

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 True or False
7. When making materiality judgments, an entity judges an
item to be material or not only on its own and not in
combination with other information in the complete set
of financial statements.
8. The Conceptual Framework and Standards specify a
uniform quantitative threshold for materiality.
9. According to the conceptual framework, revenue are
items of income that rise from the entity’s ordinary
activities while gains are those that do not arise from the
entity’s ordinary activities.
10. The Conceptual Framework is concerned with the
provision of financial information to both external users
and internal users.

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 Multiple Choice
Authoritative status
1. The Conceptual Framework (choose the
incorrect statement)
a. is not a PFRS.
b. In the absence of a standard, shall be considered by
management when making its judgment in
developing and applying an accounting policy that
results in information that is relevant and reliable.
c. Is concerned with general-purpose financial
statements only.
d. Prevails over the PFRSs in cases of conflicts.

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 Multiple Choice
Primary users
2. Which of the following statements best explains why
the reporting entity’s management and government
regulators are not considered primary users under the
Conceptual Framework?
a. These users are considered related parties, and hence do
not make relevant decisions.
b. The users have the ability to curtail the operations of the
reporting entity and therefore have the ability to affect
the entity’s going concern.
c. These users have the power to demand information they
need directly from the reporting entity.
d. All of these

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 Multiple Choice
Information on economic resources, claims, and changes
3. Information about the reporting entity’s economic
resources, claims against the reporting entity and the
effects of the transactions and other events and
conditions that change those resources and claims is
referred to in the Conceptual Framework as
information about the
a. Economic phenomena.
b. Entity’s return.
c. Financial performance.
d. Prospects for future cash flows

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 Multiple Choice
Materiality
4. Entity A is making materiality judgments. Entity
A considers the size of the impact of an item to
be material if it exceeds 5% of total assets.
What type of materiality assessment is this?
a. Quantitative.
b. Qualitative.
c. Requirement of a Standard
d. Relevance.

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 Multiple Choice
Qualitative Characteristics
5. Entity A deliberately overstated its liabilities
from P1M to P1.2M. What qualitative
characteristics is violated
a. Relevance
b. Faithful representation
c. Timeliness
d. Understandability

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 Multiple Choice
Qualitative Characteristics
6. Two primary users are using the financial
information of Entity A. If User #1 concludes
that Entity A’s sales has increased while User #2
concludes that it has decreased, Entity A’s
financial information is not
a. Relevant
b. Faithfully represented
c. Comparable
d. verifiable

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 Multiple Choice
Elements of Financial Statements
7. Which of the following is not one of the
potentials of a resource to provide future
economic benefits to an entity?
a. Service potential, i.e., the resource can be used to
provide services in the entity’s normal business
activities.
b. The resource can be converted into cash.
c. The resource has the ability to provide cost-savings
to the entity.
d. The resource causes more outflows of cash from the
entity than inflows.
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 Multiple Choice
Elements of Financial Statements
8. Which of the following would not result to
the recognition of a liability?
a. Receipt of the proceeds of a bank loan.
b. Receipt of delivery of equipment purchased on
credit.
c. A future commitment becomes burdensome
d. Paying in advance the purchase price of
inventories for future delivery.

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 Multiple Choice
Elements of Financial Statements
9. Entity A determine that an asset has ceased to
provide future economic benefits. Accordingly,
Entity A recognized immediately the carrying
amount of the asset as loss. What expense
recognition principle did Entity A use?
a. Systematic and rational allocation.
b. Immediate recognition
c. Matching
d. Impairment loss

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 Multiple Choice
Concept of Capital and Capital maintenance
10.Under the concept of capital maintenance,
profit is earned if the net assets increased
during the period after excluding the effects
of transactions with the owners.
a. Financial capital maintenance
b. Physical capital maintenance
c. Repairs and maintenance
d. Building maintenance

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