Module 2 – The Conceptual Framework

Introduction – Conceptual Framework for Financial Reporting 2018 (IFRS Framework)

History

 1989: The Framework for the Preparation and Presentation of the Financial Statements
 2010: The Conceptual Framework for the Financial Reporting
 2018: (New) Conceptual Framework for the Financial Reporting

Chapters

1. The Objective of General Purpose Financial Reporting

 To provide financial information useful to investors, lenders, and other creditors for
decision-making
 What to Report
o Economic resources and claims
o Changes in ER&C from financial performance & other events
o Financial performance reflected by accrual accounting
o Financial performance reflected by past cash flows
2. Qualitative Characteristics of Useful Financial Information
 Fundamental
o Relevance (materiality)
o Faithful representation
 Enhancing
o Comparability
o Verifiability
o Timeliness
o Understandability
3. Financial statements and the Reporting Entity
 Statement of Financial Position – assets, liabilities & equity
 Statement of Financial Performance – income & expenses
 Other statements
o Info about elements
o Cash flows
 o Contributions/distributions
o Assumptions & estimates
 Reporting period
 Going concern
 Reporting entity – entity that prepares the financial statements
o Which can be a: single entity, portion of an entity, or more than 1 entity
o To make: consolidated financial statements, unconsolidated financial
statements, or combined financial statements
4. The Elements of Financial Statements
 Financial Position – assets, liabilities, & equity
 Financial Performance – income & expenses
5. Recognition and Derecognition
 Recognition – inclusion of an element of financial statements in the statement of
financial position or statement of financial performance

 Derecognition – removal of asset/liability from the statement of financial position

6. Measurement
 Measurement basis – selection of the methodology for measuring an element of
financial statement
o Historical cost – transaction price
o Current value – fair value, value in use, & current cost
 Factors to consider
o Relevance
o Faithful representation
o Factors specific for initial recognition
7. Presentation and Disclosure
 Effective communication requires
 o Objectives & Principles – not the rules
o Classification – group similar & separate dissimilar
o Aggregation – not too many details & not excessive aggregation
8. Concepts of capital and Capital Maintenance
 Concepts of capital
o Financial – net assets: nominal monetary units & units of constant
purchasing power
o Physical – productive capacity: units of output per day

Lesson 1: The Objective of Financial Reporting

The Conceptual Framework is a summary of terms and concepts that underlie the
preparation and presentation of financial statements for external users. It is an attempt to provide
the overall theoretical foundation for accounting to guide the standard setters, preparers and users
of financial information in the preparation and presentation of statements.

It is the underlying theory for the development of accounting standards and revision of
previously issued accounting standards. It will be used in the formulation of future standards but
no changes will be made to the current standards.

The Conceptual Framework provides the foundation for Standards that:

1. Contribute transparency by enhancing international comparability and quality of financial

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

Purposes of the Revised Conceptual Framework

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

Authoritative Status of the Conceptual Framework

In case there is conflict, the requirements of the International Financial Reporting

Standards shall prevail over the Conceptual Framework.

Users of Accounting Information

The primary users of financial information are the parties to whom general purpose
financial reports are primarily directed. Such users cannot require reporting entities to provide
information directly to them and therefore must rely on general purpose financial reports for much
of the financial information they need.

 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 their investments and whether the company has the
ability to pay dividends.
 Lenders and other creditors - are interested in the information which enables them to
determine whether their loans, interest thereon and other amounts owing to them will be
paid when due.

Other users are users of financial information other than the existing and potential
investors, lenders and other creditors. They are the parties that many find the general purpose
financial reports useful but the reports are not directed to them primarily.
  Employees - are interested about the stability and profitability of the entity which enables
them to assess the ability of the entity to provide remuneration, retirement benefits and
employment opportunities.
 Customers - interested in the continuance of the entity especially when they have a long-
term involvement with or dependent on the entity.
 Government and their agencies - requires information to regulate the activities of the
entity, determine taxation policies and as a basis for national income and similar statistics.
(ex. BIR)
 Public - entities affect members of the public in a variety of ways (such as contributions).
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.
 Management – to execute plans and make decisions.

Scope of the Revised Conceptual Framework

OVERALL OBJECTIVE OF FINANCIAL REPORTING

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

The principal way of providing financial information to external users is through the annual
financial statements.

TARGET USERS

Financial reporting is directed primarily to existing and potential investors, lenders and
other creditors which compose the primary user group. The reason is that existing and potential
investors, lenders and other creditors have the most critical and immediate need for information in
financial reports because they are the providers of 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.

SPECIFIC OBJECTIVES OF FINANCIAL REPORTING

 To provide information useful in making decisions about providing resources to the entity
 To provide information useful in assessing the cash flow prospects of the entity.
 To provide information about entity resources (assets), claims (liabilities )and changes in
resources and claims (owner’s equity).

ACCRUAL ACCOUNTING

Accrual accounting means that income is recognized when earned regardless of when
received and expense is recognized when incurred regardless of when paid. Information about
financial performance measured in accordance with accrual accounting provides a better basis for
assessing past and future performance than information solely about cash receipts and payments
during a period.

LIMITATIONS OF FINANCIAL REPORTING

 General purpose financial reports do not and cannot provide all of the information that
existing and potential investors, lenders and other creditors need.
 General purpose financial reports are not designed to show the value of the entity but the
reports provide information to help the primary users estimate the value of the entity.
 General purpose financial reports are intended to provide common information to users
and cannot accommodate every request for information.
 To a large extent, general purpose financial reports are based on estimate and judgment
rather than exact depiction.

GENERAL OBJECTIVE OF FINANCIAL STATEMENTS

Financial statements provide financial information about an entity’s assets, liabilities,

equity, income, and expenses useful to users of financial statements in:

a. Assessing future cash flows to the reporting entity

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

TYPES OF FINANCIAL STATEMENTS

 Consolidated financial statements – these are the financial statements prepared when the
reporting entity comprises both the parent and its subsidiaries.
Ex. Financial statement of Company A – parent (when > 50%) & B – subsidiary
A Company and its subsidiaries
Statement of Financial Position
As of December 31, 2020
 Unconsolidated financial statements – these are the financial statements prepared when
the reporting entity is the parent alone.
Ex. Financial statement of Company A
A Company
Statement of Financial Position
As of December 31, 2020
 Combined financial statements – these are the financial statements when the reporting
entity comprises of two or more entities that are not linked by a parent or subsidiary
relationship.
Ex. Financial statement of Company A & B (Both 50%)
A & B Company
Statement of Financial Position
As of December 31, 2020

REPORTING ENTITY

 An entity that is required or chooses to prepare financial statements.

 The following can be considered a reporting entity:
o Individual, corporation, partnership, or proprietorship
o The parent alone
o The parent and its subsidiaries as single reporting entity
o Two or more entities without parent and subsidiary relationship as a single
reporting entity
 o A reportable business segment of an entity
 Ex. A Company
Statement of Financial Position
As of December 31, 2020

REPORTING PERIOD

 The period when financial statements are prepared for general purpose financial reporting.
 Financial statements must be prepared on an annual basis or a period of twelve months.
 Financial statements also provide comparative information for at least one preceding
reporting period (thus except 1st year). Example:

 Financial statements may include information about transactions and other events that
occurred after the end of reporting period if the information is necessary to meet the
general objective of financial statements.

UNDERLYING ASSUMPTIONS

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

 Going concern – in the absence of evidence to the contrary, the accounting entity is viewed
as continuing in operation indefinitely.
 Accounting entity – an accounting entity is separate and distinct from its owners,
managers, employees, or other people who constitute an entity.
  Time period – required that the indefinite life of an entity is subdivided into accounting
periods which are usually of equal length.
o Calendar year period means that the time period will start on January 1 and will end
on December 31, while fiscal year period means that the reporting period will start
on any date other than January 1.

 Monetary unit
o Quantifiability aspect – assets, liabilities, equity, income, and expenses should be
stated in terms of a unit of measure which is the peso in the Philippines.
o Stability of peso – means that the purchasing power of peso is stable or constant
and that its instability is insignificant and therefore may be ignored.

Lesson 2: Qualitative Characteristics

Qualitative characteristics are the qualities or attributes that make financial accounting
information useful to the users. In deciding which information to include in financial statements,
the objective is to ensure that the information is useful to the users in making economic decisions.
Under the Conceptual Framework, qualitative characteristics are classified into fundamental
qualitative characteristics and enhancing qualitative characteristics.

FUNDAMENTAL QUALITATIVE CHARACTERISTICS

 The fundamental qualitative characteristics related to the content or substance of financial
information. The fundamental qualitative characteristics are relevance and faithful
representation. Information must be both relevant and faithfully represented if it is to be useful.
Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a
relevant phenomenon helps users make good decisions.

APPLICATION OF QUALITATIVE CHARACTERISTICS

1. Identify an economic phenomenon that has the potential to be useful.

2. Identify the type of information about the phenomenon that would be most relevant and
can be faithfully represented.
3. Determine whether the information is available.

RELEVANCE

Relevance means the capacity of the information to influence a decision. To be relevant, the
financial information must be capable of making a difference in the decisions made by users.
Information that does not bear on an economic decision is useless.

INGREDIENTS OF RELEVANCE

Financial information is capable of making a difference in a decision if it has predictive

value and confirmatory value.

 Predictive value - financial information has predictive value if it can be used as an input to
processes employed by users to predict future outcome. In other words, if it helps users
increase the likelihood of correctly or accurately predicting or forecasting outcome of
events. For example, information about financial position and past performance is
frequently used in predicting dividend and wage payments and the ability of the entity to
meet maturing commitments.
 Confirmatory value - financial information has confirmatory value if it provides feedback
about previous evaluations. In other words, if it enables users to confirm or correct earlier
expectations. For example, a net income measure has confirmatory value if it can help
shareholders confirm or revise their expectation about an entity's ability to generate
earnings.
 Often, information has both predictive and confirmatory value. For example, an interim
income statement which provides feedback about income to date and serves as a basis for
predicting the annual income.

MATERIALITY (materiality is a relatively)

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

The materiality concept is also known as the doctrine of convenience. Materiality is really
a quantitative threshold linked very closely to the qualitative characteristics of relevance. The
relevance of information is affected by its nature and materiality. In other words, materiality is a
sub quality of relevance based on the nature or magnitude or both of the items to which the
information relates.

The Conceptual framework does not specify a uniform quantitative threshold for
materiality or predetermine what could be material in a particular situation. Very often, this is
dependent on good judgment, professional expertise and common sense.

In the exercise of judgment in determining materiality, the relative size and nature of an
item are considered. The size of the item in relation to the total of the group to which the item
belongs is taken into account. For example, the amount of advertising in relation to selling
expenses, the amount of office salaries to total administrative expenses and so on. (Another
example is when a P5,000 is immaterial to P50,000,000 but material to P100,000)

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

For example, the discovery of a P20,000 bribe is a material event even for a multibillion
company.

FAITHFUL REPRESENTATION
 Faithful representation means that financial reports represent economic phenomena or
transactions in words and numbers. Stated differently, the descriptions and figures must match
what really existed or happened. Simply worded, faithful representation means that the actual
effects of the transactions shall be properly accounted for and reported in the financial statements.

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

INGREDIENTS TO FAITHFUL REPRESENTATION

 Completeness - requires that relevant information should be presented in a way that

facilitates understanding and avoids erroneous implication. Completeness is a result of the
adequate disclosure standard. The standard of adequate disclosure means that all
significant and relevant information leading to the preparation of financial statements shall
be clearly reported. A complete depiction includes all information necessary for a use to
understand the phenomenon being depicted, including all necessary descriptions and
explanations.
 Neutrality - a neutral depiction is without bias in the preparation or presentation of
financial information. It is not slanted, weighted, emphasize, de-emphasized or otherwise
manipulated to increase the probability that financial information will be received favorably
or unfavorably by users. In other words, information must be free from bias. Neutrality is
synonymous with the principle of fairness. Neutrality is supported by prudence and
conservatism. Prudence is the exercise of care and caution when dealing with the
uncertainties in the measurement process such that assets or income are not overstated
and liabilities or expenses are not understated. Conservatism means in case of doubt,
record any loss and do not record any gain.
 Free from Error - it means there are no errors or omissions in the description of the
phenomenon or transaction. In this context, free from error does not mean perfectly
accurate in all respects. For example, an estimate of an unobservable price or value cannot
be determined to be accurate or inaccurate. However, a representation of that estimated
can be faithful if the amount is described clearly and accurately as an estimate. As long as
the estimate is clearly and accurately described and explained, even a high level of
measurement uncertainty does not affect the usefulness the financial information. (The
process used to produce the reported information has been selected and applied with no
errors in the process).
SUBSTANCE OVER FORM

 The economic substance of transactions and events are usually emphasized when economic
substance differs from legal form.
 Not considered a separate component of faithful representation.

ENHANCING QUALITATIVE CHARACTERISTICS

The enhancing qualitative characteristics relate to the presentation or form of the financial
information. The enhancing qualitative characteristics are intended to increase the usefulness
of the financial information that is relevant and faithfully represented. Relevant and faithfully
represented financial information is useful but the information would be most useful if it is
comparable, understandable, verifiable and timely.

 Comparability - the ability to bring together for the purpose of noting points of likeness
and difference. It is the enhancing qualitative characteristic that enables users to identify
and understand similarities and dissimilarities among items. Implicit in the qualitative
characteristic of comparability is the principle of consistency. In a broad sense, consistency
refers to the use of the same method for the same item, either from period to period within
an entity or in a single period across entities.
o Comparability – between and across entities (dimensional and intercomparability)
allows comparison between two or more entities engaged in the same industry.
o Comparability – within an entity (horizontal and intracomparability) allows
comparison within a single entity through time. Ex. 2019 and 2018 records
o Comparability is not the same as consistency but it is implicit in the qualitative
characteristics of comparability.
  Understandability - requires that financial information must be comprehensible and
intelligible if it is to be most useful. It is assumed however that users for whom the financial
statements were prepared have a reasonable knowledge of business and economic
activities and who review and analyze the information diligently.
 Verifiability - means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation. Verification can be direct or indirect. Direct verification means
verifying an amount or other representation through direct observation. Indirect
verification means checking the inputs to a model, formula or other technique and
recalculating the inputs using the same methodology.
 Timeliness - financial information must be available or communicated early enough when
a decision is to be made. The older the information, the less useful.

COST CONTRAINT ON USEFUL INFORMATION

 Cost is a pervasive constraint on the information that can be provided by financial reporting
 The benefit derived from the information should exceed the cost incurred in obtaining the
information

Lesson 3: Conceptual Framework - Elements, Recognition, Measurement and Presentation of

the Statement of Financial Position

Financial statements portray financial effects of transactions and other events by grouping
them into broad classes called “elements of financial statements” according to their economic
characteristics. The elements are the building blocks from which financial statements are
constructed. The elements directly related to the measurement of financial position are:

 Assets
 Liability
 Equity

ASSETS

Under the Revised Conceptual Framework, an asset is defined as a present economic

resource controlled by the entity as a result of past events.

Essential characteristics of an asset:

  Present economic resource
 Right that has the potential to produce economic benefits
 Controlled by the entity as a result of past events.

Right

Rights that have the potential to produce economic benefits may take the following forms:

1. Rights that correspond to an obligation of another entity

2. Rights that do not correspond to an obligation of another entity
3. Rights established by contract or legislation

Potential to Produce Economic Benefits

 It does not need to be certain or even likely that the right will produce economic benefits, it
is only necessary that the right already exists.
 An economic resource could produce economic benefits I an entity is entitled:
o To receive contractual cash flows
o To exchange economic resources with another party on favorable terms
o To produce cash inflows or avoid cash outflows
o To receive cash by selling the economic resource
o To extinguish a liability by transferring an economic resource

Control of an Economic Resource

 An entity controls an asset if it has the present ability to direct the use of the asset and
obtain economic benefits that flow from it.
 Control may arise if an entity enforces legal rights, but legal rights is not necessary as long
as the entity has other means of ensuring that no other party can benefit from an asset.

LIABILITY

Liability is a present obligation of an entity to transfer an economic resource as a result of

past events.

Essential characteristics of liability:

 The entity has an obligation

  The obligation is to transfer an economic resource
 The obligation is a present obligation that exists as a result of past event

Obligation

 An obligation is a duty or responsibility that an entity has no practical ability to avoid:

 It can either be legal or constructive.

Transfer of an Economic Resource

Obligation to transfer an economic resource include:

a. Obligation to pay cash

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

Past Events

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

a. An entity has already obtained economic benefits

b. An entity must transfer an economic benefit

RECOGNITION

The Revised Conceptual Framework defines recognition as the process of capturing for
inclusion in the financial statements an item that meets the definition of an asset, liability, equity,
income or expense. The amount at which an asset, a liability or equity is recognized in the
statement of financial position is reported as carrying amount. Recognition links the elements to
the statement of financial position and statement of financial performance.

Recognition Criteria

Only items that meet the definition of an asset, a liability or equity are recognized in the
statement of financial position. In addition, items are recognized only when their recognition
provides users of financial statements with information that is both relevant and faithfully
represented.

Derecognition

The removal of all or part of a recognized asset or liability from the statement of financial
position. Derecognition of an asset occurs when the entity loses control of all or part of the asset.
Derecognition of a liability occurs when the entity no longer has a present obligation for all or part
of the liability.

Measurement

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

statements. The Revised Conceptual Framework mentions two categories:

 Historical cost - in case of asset, the cost incurred in acquiring or creating the asset
comprising the consideration paid plus transaction cost. In the case of liability, the
consideration received to incur the liability minus transaction cost.
 Current value - includes fair value, value in use for asset, fulfillment value for liability and
current cost.
o Fair value - for an asset, it is the price that would be received to sell an asset in an
orderly transaction between market participants at measurement date. For a
liability, it is the price that would be paid to transfer a liability in orderly transaction
between market participants at the measurement date.
o Value in use - the present value of the cash flows that an entity expects to derive
from the use of an asset and from the ultimate disposal.
o Fulfillment value - the present value of cash that an entity expects to transfer in
paying or settling a liability.
o Current cost - of an asset, is the cost of an equivalent asset at measurement date
comprising the consideration paid and transaction cost. Current cost of a liability is
the consideration that would be received less any transaction cost at measurement
date.

Selecting a Measurement Basis

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

Presentation and Disclosure

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

 Classification – the sorting of assets, liabilities, equity, income and expenses on the basis of
shared or similar characteristics.
 Aggregation – adding together of assets, liabilities, equity, income and expenses that have
similar or shared characteristics and are included in the same classification.

Financial Statements

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

 Statement of financial position

 Income statement
 Statement of comprehensive income
 Statement of changes in equity
 Statement of cash flows
 Notes, comprising of summary of significant accounting policies and other explanatory
notes.

Frequency of Reporting

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

 The period covered by the financial statements.

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

Statement of Financial Position

 The statement of financial position is a formal statement showing the three elements
comprising financial position, namely assets, liabilities and equity. It is used to evaluate factors as
liquidity, solvency and the need of the entity for additional financing.

Classification of Assets

Assets are classified into two, namely current assets and noncurrent assets. An entity shall
classify an asset as current when:

 The assets is cash or cash equivalent unless the asset is restricted to settle a liability for
more than twelve months after the reporting period
 The entity holds the asset primarily for the purpose of trading
 The entity expects to realize the asset within twelve months after the reporting period.
 The entity expects to realize the asset or intends to sell or consume it within the entity’s
normal operating cycle.

Presentation of Current Assets

Current assets are usually listed in the order of liquidity. PAS 1, paragraph 54, provides that
as a minimum, the line items under current assets are:

 Cash and cash equivalents

 Financial assets at fair value such as trading securities and other investments in quoted
equity instruments
 Trade and other receivables
 Inventories
 Prepaid expenses

Presentation of Noncurrent Assets

An entity shall classify all other assets not classified as current as noncurrent. Noncurrent
assets include the following:

 Property, plant and equipment

 Long-term investments
 Intangible assets
 Deferred tax assets
  Other noncurrent assets

Classification of Liabilities

Liabilities are classified into two, namely current liabilities and noncurrent liabilities. An
entity shall classify a liability as current when:

 The entity expects to settle the liability within the entity’s normal operating cycle.
 The entity holds the liability primarily for the purpose of trading.
 The liability is due to be settled within twelve months after the reporting period.
 The entity does not have an unconditional right to defer settlement of the liability for at
least twelve months after the reporting period.

Presentation of Current Liabilities

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

 Trade and other payables

 Current provisions
 Short-term borrowing
 Current portion of long-term debt
 Current tax liability

Presentation of Noncurrent Liabilities

All liabilities not classified as current are classified as noncurrent:

 Noncurrent portion of long-term debt

 Finance lease liability
 Deferred tax liability
 Long-term obligations to company officers
 Long-term deferred revenue

Currently Maturing Long-Term Debt

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

Discretion to Refinance

 If the entity has the discretion to refinance or roll over an obligation for at least twelve
months after the reporting period under an existing loan facility, the obligation is classified
as noncurrent even if it would otherwise be due within a shorter period.
 Note that the refinancing or rolling over must be at the discretion of the entity.

Covenants

Covenants are restrictions on the borrower as to undertaking further borrowings, paying

dividends, maintaining specified level of working capital and so forth. Under these covenants, if
certain conditions relating to the borrower’s financial situation are breached, the liability becomes
payable in demand. If there is breach of covenant, the liability is classified as current except if the
lender has agreed on or before the end of the reporting period to provide a grace period ending at
least twelve months after the end of reporting period.

Equity

Equity is the residual interest in the assets of the entity after deducting all of its liabilities.
The terms used in reporting the equity of an entity depending on the form of business organization
are:

 Owner’s equity in proprietorship

 Partners’ equity in partnership
 Stockholders’ equity or shareholders’ equity in a corporation

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

Notes to Financial Statements

 Notes to financial statements provide narrative description or disaggregation of items
presented in the financial statements and information about items that do not qualify for
recognition. The purpose is to provide the necessary disclosures required by Philippine Financial
Reporting Standards.

Forms of Statement of Financial Position

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

 Account form – The presentation follows that of an account, meaning, the assets are shown
on the left side and the liabilities and equity on the right side of the statement of financial
position.
Line Items in the Statement of Financial Position

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

1. Cash and cash equivalents

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

The standard does not prescribe the order or format in which items are to be presented in
the statement of financial position.

Lesson 4: Conceptual Framework - Elements, Recognition, Measurement and Presentation of

the Statement of Financial Performance

Income

Income is defined as increases in assets or decreases in liabilities that result in increases in

equity, other than those relating to contributions from equity holders. The definition encompasses
both revenue and gains.

 Revenue – arises in the course of the ordinary regular activities and is referred to by
variety of different names including sales, fees, interest, dividends, royalties and rent.
 Gains – represent other items that meet the definition of income and do not arise in the
course of the ordinary regular activities.

Expenses

An expense is defined as decreases in assets or increases in liabilities that result in

decreases in equity, other than those relating to distributions to equity holders. Expenses
encompass losses as well as those expenses that arise in the course of the ordinary activities.

 Expenses – arise in the course of ordinary regular activities.

 Losses – do not arise in the course of the ordinary regular activities.

Statement of Financial Performance

This refers to the statement of profit and loss and a statement presenting other
comprehensive income. It is the primary source of information about an entity’s financial
performance. As a general rule, all income and expenses are included in profit or loss.

Recognition

Only items that meet the definition of income or expense are recognized in the statement of
financial position.
  Point of sale income recognition – the basic principle that income shall be recognized
when earned.
 Expense recognition – expenses are recognized when incurred.

Expense recognition is also an application of the matching principle. The matching principle has
three applications, namely:

 Cause and effect association

 Systematic and rational allocation
 Immediate recognition

Classification of Income and Expense

Income and expenses are classified as components of profit and loss and components of
other comprehensive income. The Revised Conceptual Framework has introduced the term
statement of financial performance to refer to the statement of profit or loss together with the
statement presenting other comprehensive income.

Capital Maintenance

The financial performance of an entity is determined using two approaches, namely

transaction approach and capital maintenance approach.

 Transaction approach – traditional preparation of an income statement.

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

The Conceptual Framework considered two concepts of capital maintenance or well-

offness, namely financial capital and physical capital.

Income Statement

It is a formal statement showing the financial performance of an entity for a given period of
time. The transaction approach is also known as the results of operations of the entity. Information
about financial performance is useful in predicting future performance and ability to generate
future cash flows.

Comprehensive Income

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

 Components of profit or loss – total income less expenses, excluding the components of
other comprehensive income.
 Other comprehensive income – comprises items of income and expenses including
reclassifications that are not recognized in profit or loss as required or permitted PFRS.

Other Comprehensive Income

The components of other comprehensive income include the following:

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

Presentation of Other Comprehensive Income

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

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

OCI that will be reclassified to profit or loss

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

OCI that will be reclassified to retained earnings

 Unrealized gain or loss on equity investment measured at fair value through other
comprehensive income.
 Revaluation surplus during the year
 Remeasurements of defined benefit plan, including actuarial gain or loss.
 Change in fair value attributable to credit risk of a financial liability designated at fair value
through profit or loss.

Presentation of Comprehensive Income

1. Two statements
 An income statement
 A statement of comprehensive income
2. Single statement – combined statement showing the components of profit or loss and
components of other comprehensive income in a single statement.

Sources of Income

 Sales of merchandise to customers

 Rendering of services
 Use of entity resources
 Disposal of resources other than products

Components of Expense

 Cost of goods sold or cost of sales

 Distribution cost of selling expenses
 Administrative expenses
 Other expenses
 Income tax expense
No More Extraordinary Items

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

Line Items

 Revenue
 Gain and loss from the derecognition of financial asset measured at amortized cost as
required by PFRS 9.
 Finance cost
 Share in income or loss of associate and joint venture accounted for using the equity
method.
 Gain or loss on the reclassification of financial asset from amortized cost to fair value profit
or loss.
 Gain or loss on the reclassification of financial asset from fair value other comprehensive
income to fair value profit or loss.
 Income tax expense
 A single amount comprising discontinued operations
 Profit or loss for the period
 Total OCI
 Comprehensive income for the period

Forms of Income Statement

 Functional presentation – classified expenses according to function as part of cost of

goods sold, distribution cost, administrative expenses and other expenses.
 Natural presentation – expenses are aggregated according to their nature and not
allocated among the various functions within the entity.

PAS 1 does not prescribe any form of income statement.

Statement of Comprehensive Income

This starts with the profit or loss as shown in the income statement plus or minus the
components of other comprehensive income. The purpose is to provide a more comprehensive
information on financial performance measured more broadly than the income as traditionally
computed.

Statement of Retained Earnings

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

 Profit or loss for the period

 Prior period errors
 Dividends declared and paid to shareholders
 Effect of change in accounting policy
 Appropriation of retained earnings.

Statement of Changes in Equity

A basic statement that shows the movements in the elements of components of the
shareholders’ equity. It must show the following:

 Comprehensive income for the period

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

Statement of Cash Flow

It is a basic component of the financial statements which summarizes the operating,

investing and financing activities of an entity.