CHAPTER 1 THE ACCOUN CY PROFESSION Definition of accounting The Accounting Standards Council provides the following definition Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic dec ion. 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 ina significant manner and in terms of money, transactions and events which are in part atleast ofa financial x and interpreting the results thereof. characte: 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.Nr j- 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 defi nition states that the very purpose of accounting is toprovide 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 nonrecognition 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, liabilities 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 ecounting. Sociological and psychological matters are ond-the province of accounting. fot L-Tov€ :External and internal transactions Eco aeey . ; whieh me activities of an entity are referred to as transactions h may be classified as external and internal. External transactions or exchange transactions are those economic events involving one entity and another entity. Purche ‘i ‘ E ‘urchase of merchandise from a supplier, borrowing money rom a bank, sale of merchandise to customer and payment of salaries to employees are examples of external transactions. Internal transactions are economic events involving the entity only. These 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 products. Casualty is any sudden and unanticipated I from fire, flood, earthquake and other event ordinar 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, current cost, realizable value and present value. Historical cost is the most common measure of financial transactions. 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 “niversal language of business’. 3External and internal transactions Peonomic activities of an entity are referred to as fransactions which may be classified as external and internal. External transactions or exchange transactions are those economic events involving one entity and another entity. Purchase of merchandise from a supplier, borrowing money from a bank, sale of merchandise to customer and payment of salaries to employees are examples of external transactions Internal transactions ave economic events involving the entity only. These 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 products. 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, current cost, realizable value and present value. Historical cost is the most common measure of financial transactions. Communicating Communicating is the process of preparing and distributing accounting reports to pctential 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”. 3Imphcit in the communication process are the recording, classifying and summarizing aspects of accounting. tematically Recording or journalizing is the process of 8) . maintaining a record of all economic business transaction 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, These reports tell us how well an entity is performing in terms of profit and loss and where it 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 decisions." An accountant’s primary task is to supply financial information so that the statement users could make informed judgment and better decision. : 4THE ACCOUNTANCY PROFESSION 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 and 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 arround the country. Limitation of the practice of public accountancy Je practitioners and partnerships for the practice of public Sing! hall be registered certified public accountants in accountancy Ss! 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. 5Accreditation to practice public accountancy Certified public accountants, firms and part antec public accountants, including partners and norte untan, s thereof, are required to register with the Board of Accountancy and Professional Regulation Commission for the practice of public accountaney. The Professional Regulation Commission upon favorable Coc endation of the Board of Accountancy shall issue the Certificate of Registration to practice public accoufitancy which shall be valid for 3 years and renewable every 3 years upon payment of required fees. Certified Public profession in three private accounting Public The field of public accounting or of individual practitioner multinational organizatior financial services to the Public accountants collect professional fees for their services, much the same as lawyers and doctors do. Public accountants usually offer namely auditing, taxation and mana Accountants generally practice their main areas, namely public accounting, and government accounting. ccounting public accountancy is composed » small accounting firms and large that render independent and expert public. three kinds of sery wgement advisory ge ct, large multination. m for each of these Auditing has traditionally been the by most public accounting pr: ices, Tvices, As a matter of separate divisio: al accounting firms have services primar ‘actitioners, Auditing or specifically external examination of financial statements by independent certified public accountant for the purpose of expre, sing ini the fairness with which the financial state prepared”. Actually, external auditing is the "attest faneders independent CPAs. of Y Service offered auditing is the « The Bureau of Internal Revenue re statements to accompany the filing o} al income tax return, 6Banks and other lending institutions fr audit by an independent CPA before gr: borrower quently require an nting a loan to the Creditors and pre spective investors place considerable reliance on audited financial statements on making economic decision. 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 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 policie organization procedures, product costs, distribution and many other phases of business conduct and operations Specifically, management advisory services include advice on installation of computer system, quality control installation and modification of accounting system, budgeting, forecasting, design or modification of retirement plans and even entity mergers and takeovers. 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 ean producing the financial reports, preparing ns anticy, : controlling and allocating the resources of the entity The private accountant has also the respon: ao ee determination of the various taxes the entity is oblig pay. Government accounting Government accounting “encompasses the prpce ss yo analyzing, classifying, summarizing and communicating a transactions involving the receipt and disposition 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 the Bureau of Internal Revenue, Commission on Audit, Department of Budget and Management, Securities and Exchange Commission and even in a police agency like the National Bureau of Investigation. Continuing professional development (CPD) Under Resolution 59 of the Board of Accountancy, the term Continuing Professional Development is used in lieu of Continuing Professional Education. All certified public accountants shall requirements, rules and regulations 0 professional development to be promulgated Accountancy, subject to the approval of tl Regulation Commission, in coordination wit! national professional organization of c accountants or any duly accredited educatio: abide by the n continuing by the Board of he Professional h the accredited ertified public nal institutions. Continuing professional develo inculcation, assimilation and acquisition of knowledge, skill proficiency, and ethical and moral values after the initial registration of the Certified Public Accountant, pment refers to the 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. The total CPD credit units shall be 60 credit units for three years. Under the new BOA Resolution, the required 60 credit units may be earned in any of the three years preceding the year of application for accreditation. 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. Exemptions 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. A CPA shall be temporarily exempted from compliance with the CPD requirements under the following circumstances: a. The CPA is working or practicing the profession or furthering studies abroad. b. The exemption is for the duration of stay abroad. c. The CPA has been out of the country for at least two years immediately prior to the date of renewal of license and accreditation.Accounting versus auditing In a broad sense, ¢ 1s one of the areas of ‘counting embraces auditing. Auditing counting specialization. Ina limited sense, accounting is essentially constructive in nature. i 2 s are Accounting ceases when financial statement 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 a begin to perform the task of au re prepared, the auditor will diting. The auditor examines the financial statements to as certain. 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 cone erned with the why, reason or justification for any action adopted. Bookkeeping is a procedural element of a ccounting as arithmetic is a procedural element of m athematics. Accounting versus accountancy Broadly speaking, the two terms are sy ynonymous beea: both refer to the entire field of accow 1 use they nting theory and practice, accountancy refe ion of accounting practice. Technically speaking, however profe: rs to the Accounting is used in reference onl: ly to a particular field of accountancy such as public accounting, private accounting and government accounting, 10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 focuses on general purpose reports known as financial statements intended for internal and external users. 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 “pules, 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 social process which incorporates political actions of various interested user groups as well as professional judgment, logic and research. 11Boe . Purpose of accounting standards The over: proper present; all purpose of accounting standards is to identify accounting practices for the preparation and ation of financial statements. Accounting standards create a common understanding betw “en preparers and users of financial statements particularly the measurement of assets and liabilities. A set of high-quality accounting standards is a necessity to ensure comparability and uniformity in financial statements based on the same financial information. FINANCIAL REPORTING STANDARDS COUNCIL In 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. 12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 Securities and Exchange Commission Bangko Sentral ng Pilipinas Bureau of Internal Revenue Commission on Audit Major organization of preparers and users of financial statements — Financial Executives Institute of the Philippines or FINEX Accredited national professional organization of CPAs: Public Practice Commerce and Industry Academe or Education Government Total IT eo 10 09 20 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 Interpretations Committee or PIC was formed by the FRSC in August 2006 and has replaced the Interpretations 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 in the context of the Conceptual Framework, 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 clearcut 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 Interpretations Committee or SIC. 13INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE The International Accounting Standards Committee or IASC is an independent private sector body, with the objective of hieving 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 Ircland, and the United States of America. The IASC is headquartered in London, United Kingdom. Objectives of IASC a. To formulate and publish in the public interest 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 "[nternational Accounting Standards" or IAS. The IFRS is a global phenomenon intended to bring about greater transparency and a higher degree of comparability in financial reporting. 14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. However, at present, the FRSC has adopted in their entirety all International Accounting Standards and International Financial Reporting Standards. 4.) The move toward IFRS is essential to achieve the goal of one wlest niform and globally accepted financial reporting standards. Co 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 internalization 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 i accountin standards by the World Bank, Asian Development Bank and World Trade Organization. 15i dards Philippine Financial Reporting Standar The Financial Reporting Standards pounel ieee ata in @ series of pronouncements called "Philippi eee 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 Ac ounting Standards which correspond to International counting Standards. a The Philippine Accountin, same as their counter Standards. g Standards are numbered the part in International Accounting c. Philippine Interpretations which correspond to Interpretations of the IFRIC and the Standing Interpretations Committee, a and Interpretations developed by the Philippine Interpretations Committee. 16CHAPTER 2 CONCEPTUAL FRAMEWORK Assumptions and financial reporting 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. fl Boing concert However, implicit in accounting are the basic assumptions of accounting entity, time period and monetary unit, Accordingly, the four basic accounting assumptions are as follows: Going concern Accounting entity Time period Monetary unit Pepe i Bi saekin0 4 Going concern The going concern assumption means that in the absence of evidence to the contrary, the accounting entity IS view das continuing in operation indefinitely. In other words, the financial statements are normally prepared on the assumption that the entity will continue 19 operations for the foreseeable future jf 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. This postulate is the very foundation of the cost principle. It is also known as the continuity assumption. If there is evidence that the entity would experience large and persistent losses of that the entity’s operations a to bé& terminated, the going concern “assumption bandone ——————— 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. 31ah. a, =e ak oe a ee The personal tr: ‘ansactions of the owners shail not be allowed to distort the fi nancial 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 i Prepared for each business in order to determine which 1 usiness. is profitable. Each business is an independent accounting entity. When a major shareholder of a corporation borrows money from a bank on hi ‘is own personal account, the loanisa liability of the shareholder alone and not of the corporation. \ The shareholder is not the corporation and the corporation is not the shareholder. However, where parent and subsidiary relationship exists, consolidated statements for the affiliates are usually made because for practic ical 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 annn ti entity is finally dissolved and liquidate Only then can the final net income and networth of the entity be determined precisely. However, users of fi m need timely nancial informatio information for making an economic decision. It becomes necessary therefore to Prepare periodic reports on financial position, performance and cash flows of an entity, 32The time period assumption requires that “the indefinite life of an entity is subdivided into time periods or accounting periods which are usually of equal length for the purpose of preparing financial reports on financial position, performance and cash flow. 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 sT- ‘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 ee Monetary unit The monetary unit assumption has two aspects, namely quantifiability and stability of the peso. pislacbnas’4 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. Q. The stability of the peso assumption means that the inh ‘ 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. 33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 ¢quipment that 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 €quipment 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 P4,500,000, considering a current exchange rate of P45 to $1. Obviously, there is a significant gap between historical cost and current replacement cost. ¥ In this regard, PAS 16 provides that an entity shall choose either the cost model or revaluation model as an accounting Policy and shall apply that policy to an entan class of Property, plant and equipment. 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, ) The Conceptual Framework ig an attempt to provide an overall theoretical foundation for accounting which will guide standard-setters, preparers and users of financial information in the Preparation and presentation of statements. 34It is the under! standards an. standards, pe theory for the development of accounting “revision of previously issued accounting The C onceptual Framework i financial state statements, is concerned with general purpose Ments, including consolidated financial The financial statem ‘ ents are prepared at least annually and are directed toy ‘d the common needs of a wide range of However, special purpose financial reports, for example, prospectuses and computations prepared for taxation purposes, are outside the scope of the Conceptual Framework. ats Purposes of Conceptual Framework a. To assist the FRSC in developing accounting standards that will represent Philippine GAAP. b. To assist preparers of financial statements in applying accounting standards and in dealing with issues not yet covered by GAAP. ‘e. To assist the FRSC in the review and adoption of International Financial Reporting Standards. a. To assist users of financial statements in interpreting the information contained in the financial statements. e. To assist auditors in forming an opinion as to whether financial statements conform with Philippine GAAP. f. To provide information to those interested in the work of the FRSC in the formulation of PFRS. 35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 deveioping 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 a Philippine Financial Reporting Standard. The Conceptual Framework does not define standard for any particular measurement or disclosure issue. Nothing in this Conceptual Framework overrides any specific Philippine Financial Reporting Standard. In case where there is a conflict, the requirements of the Philippine 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. 36 aPrimary users The primary users of financial information are the parties to whom general purpose financial réports are primarily directed. as nrectees Such users cannot require reporting entities to provide information directly to them and therefore must rely on general purpose financial reports for much of the financial information they need: /xisting 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 Joans, interest thereon and other amounts owing to them will be paid when due. del Other users a e By residual definition, "other users" are users of financial information other than the existing and potential investors, lenders and other creditors. Other users are $0 called because they are parties that may find the general purpose financial reports useful but the reports are not directed to them primarily. 37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 in 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 trend and the range of its activities. Scope of Conceptual Framework a. Objective of financial reporting b. Qualitative characteristics of useful financial information c. Definition, recognition and measurement of the elements from which financial statements are constructed d. Concepts of capital and capital maintenance 38Financial reporting Financial repori ree eon is the provision of financial information ¥ to external users that is useful to them in making cc an e Conomic decisions and for assessing the effectiveness ntity's Management. The principal y external users js y of providing financial information to through the annual financial statements However, financial reporting encompasses not only financial statements but also other meang of communicating information that relates directly or indirectly to the financial accounting process. Financial reports include not only financial statements but also other information such as financial highlights, summary of importe cial figures, a is of financial statements : + pO a and significant _ratigs. Financial reports also include nonfinancial information such as description of major products and a listing of corporate OBJECTIVE OF FINANCIAL REPORTING The objective of financial reporting forms the foundation of the Conceptual Framework. Other aspects of the Conceptual Framework, such as the qualitative characteristics of useful information and measurement of the clements of financial statements, flow logically from the objective. Phe overall objective of financial reporting is to provide ce ‘moneial information about the reporting entity Rat is-useful — fo existing al 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. 39Target users Financial reporting is directed primarily to the existing and potential investors, lenders and other creditors which ee —— compose the primary \ser 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". Specifically, the Conceptual Framework for Financial Reporting states the following objectives of financial reporting: a. To provide information useful in making decisions about — providing resources to the entity. b. To provide information useful in assessing the prospects 7 of future net cash flows to the entity. c. To provide information about entity resources, claims and 7 changes in resources and claims. 40Economic decisions Existing and potential investors need general purpose financial reports in order to enable them in making decisions whether to buy, i a i 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. - TT a Assessing future cash flows 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 rece Ee 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 expec ee onsequently, financial reporting should provide information that is useful in assessing the amount, timing and uncertainty of prospects for future net cash inflows to the entity. ee NP 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 yesources and the claims against the reporting entity. The economic resources are the assets and the claims are the Habilities and equity of the entity. In other words, the financial position comprises the assets, jiabilities and equity of an entity at a particular moment in time. 41Information about the nature and amounts of a 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 fi A —_—_— need for additional financin: 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 entily. 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 ana aeoe——e transactions, such as issuing debt or equity instruments. The financial performance of an entity comprises revenue, expénses 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, § —————_______ ery. = 42Usefulness of financial performance Information about financial performance helps users to und erstand the return that the entity has produced on the economic resource: 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 entity's economic resources. Information about past financial performance and how management discharged its responsibilities is usually helpful in predicting the future returns on the entity's economic resources. | Information about financial performance during a period is useful is assessing the entity's past and future ability to generate net cash inflows frewoperattons, Accrual accounting The financial performance of an entity shall be measured in accordance with accrual accounting. ee 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 scour 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. ‘The transactions are recorded and reported in the financial statements of the periods to which they relate. Simply stated, accrual accounting means that income is recognized when earned regardless of when received and s recognized when incurred regardless of when expense paid. 43The essence of accrual accounting is the recognition of accounts receivable, accounts payable, prepaid expenses, accrued expenses, deferred income and accrued income. Information about financial performance measured in accordance with accrual accounting provides a better basis fe or 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 ox act depiction. 44