conceptual framework of accounting

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Financial Reporting Systems

Presentation on

1. Conceptual Framework of Accounting

2. Presentation of Financial Elements

Conceptual Framework of Accounting

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Accounting in the Philippines

• November 1981 – PICPA formed the Accounting Standard Council (ASC) to establish the generally accepted accounting principles (GAAP) in the Philippines. Approved work or statements of the ASC were known as Statement of Financial Accounting Standards (SFAS)

• 1996 to 1997 – Philippine accounting standards were based on the approved International Accounting Standards (IAS) issued by the International Accounting Standard Committee (IASC).

• May 13, 2004 – approval of RA 9298, the Philippine Accountancy Act of 2004.

• 2006 – the Board of Accountancy established the Financial Reporting Standards Council (FRSC) to replace the ASC. FRSC monitors the technical activities of the International Financial Accounting Standards Board (IASB) and issues Invitation to Comment on drafts of proposed International Financial Reporting Standards (IFRS). At present, the FRSC issues Philippine Financial Reporting Standards (PFRS) which corresponds to the IFRS.

International Financial Reporting Standards

• Accounting standards – are authoritative statements of how particular types of transactions and other events should be reflected in financial statements.

• International Financial Reporting Standards (IFRS) – a series of pronouncements published by the IASB – IFRS are the required accounting standards.

– IFRS Framework describes the basic concepts that underlie the preparation of Financial Statements for external users

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Users of Accounting Information

I. External Users (not involved in the daily operations of the entity) – Owners, stockholders, creditors, potential

investors, suppliers, customers, labor unions, government agencies, trade associations and the public.

II. Internal Users – Board of Directors, Chief Executive Officers, Chief

Financial Officers, Vice Presidents, business unit managers, plant managers, and the supervisors.

Framework for the Preparation of Financial Statements

• The Framework sets out the concepts that underlie the presentation of financial statements for external users. It is a guideline and not a PFRS. The general objective of the Framework is to facilitate the consistent and logical formulation of PFRSs.

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BASIC PRINCIPLES

• In order to generate useful information to users of Financial Statements, accountants rely on the following principles:

Objectivity Principle

Historical Cost

Revenue Recognition Principle

Expense Recognition Principle

Adequate disclosure

Materiality

Consistency Principle

BASIC PRINCIPLES

• Objectivity Principle – accounting records and statements are based on the most reliable data available so that they will be as accurate and useful as possible.

• Historical Cost – acquired assets are recorded at their actual cost.

• Revenue Recognition Principle – revenue is recognized when goods are delivered or services are performed.

• Expense Recognition Principle – expenses should be recognized in the period in which goods and services are used up to produce revenue.

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BASIC PRINCIPLES

• Adequate Disclosure – all relevant information that would affect the user’s understanding and assessment of the accounting entity should be disclosed

• Materiality – financial reporting is only concerned with information that is significant enough to affect valuations and decisions.

• Consistency Principle – firms should use the same accounting method from period to period to achieve comparability over time in a single enterprise.

Qualitative Characteristics of Useful Financial Information

• Relevance

• Faithful representation *Information most be both relevant and faithfully represented if it is to be useful.

• Completeness

• Neutrality

• Freedom from Error

Fundamental Qualitative Characteristics

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• Relevance – financial information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both.

• Predictive role – when the information is used to make predictions of future cash flows or income. For information to be relevant, it should assist in either the confirmation of past predictions or in the making of new predictions.

• Confirmatory role – when information is used to confirm or correct the decision-maker’s earlier expectations (achievement vs. expectations).


• Faithful representation – to be useful, financial information must not only be relevant, it must also represent faithfully the phenomena it purports to represent. – Completeness – a complete depiction includes all

information necessary for a user to understand the phenomenon being depicted.

– Neutrality – free from bias.

– Freedom from Error – no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process.

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Enhancing Qualitative Characteristics

qualitative characteristics that enhance the usefulness of information that is relevant and faithfully presented.

• Comparability – information is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or date.

• Verifiability – assure users that information represents faithfully the economic phenomena it purports to represent.

• Timeliness – information is available to decision-makers in time to be capable of influencing their decisions.

• Understandability – classifying, characterising and presenting information clearly and concisely makes it understandable.

ELEMENTS OF FINANCIAL STATEMENTS

• Measurement of financial position (Balance Sheet) = assets, liability, equity

• Measurement of performance (Income Statement) = income, expenses

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Measurement of the Elements of Financial Statements

• Historical cost. Assets are recorded at the amount of cash or cash equivalents paid or fair value of the consideration given to acquire them at the time of their acquisition. Liabilities are recorded at the amount of proceeds received in exchange for the obligation.

• Current cost. Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the undiscounted amount that would be required to settle the obligation currently.

• Realizable Value. Assets are carried at the amount that could currently be obtained by selling an asset in an orderly disposal.

• Settlement Value. Liabilities are carried at the undiscounted amount expected to be paid to satisfy the liabilities in the normal course of business.

Elements of Financial Statements

• FINANCIAL POSITION:

• ASSETS – a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

• Ex. Cash; cash equivalents; notes receivable; inventories; prepaid expenses; property, plant and equipment; investments; intangible assets; other assets.

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• LIABILITIES – obligations of the entity to outside parties who have furnished resources. It is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

• Ex. Notes payable, accounts payable, accrued liabilities, unearned revenues, mortgage payable, bonds payable, and other debts



• EQUITY – the residual interest in the assets of the enterprise after deducting all its liabilities.

• Ex. Owner’s equity, Partner’s equity, Share capital, Retained earnings, and reserves

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• PERFORMANCE: • INCOME – increases in economic benefits during the

accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.

• Revenue – arises in the course of the ordinary activities of an enterprise and is referred to by a variety of other names such as sales, fees.

• Gains – represent other items that meet the definition of income and may, or may not, arise in the course of ordinary activities of an enterprise. Represent increases in economic benefits.


• PERFORMANCE: • EXPENSES – decreases in economic benefits during the

accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

• Classifications of Expenses: cost of services or goods sold, distribution or selling expenses, administrative expenses or other operating expenses.

• Losses – represent other items that meet the definition of expense and may, or may not, arise in the course of ordinary activities of an enterprise. Represent decreases in economic benefits.

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Concepts of Capital and Capital Maintenance

• Financial concept. Capital is synonymous with the net assets or equity of the enterprise.

• Physical concept. Capital is regarded as the productive capacity of the enterprise.

Presentation of Financial Elements

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The Accounting Cycle

Analyzing

Journalizing

Posting

Preparing T/B

Adjusting entries

Worksheet

Financial Statements

Closing entries

Post-closing T/B

Reversing entries

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Statement of Financial Position

• A Statement of Financial Position is a structured financial statement that shows, the assets, liabilities, and equity of a business entity as of a given date.

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FORMAT OF STATEMENT OF FINANCIAL POSITION

• Report Form – Assets, Liabilities and Equity (in that order) are shown in vertical manner.

• Account Form – follows the T-Account format where Assets are shown in the left side, while Liabilities and Equity are on the right side.

• Financial Position Form – emphasizes the working capital position of an enterprise. Presented in vertical form, current liabilities - current assets ( = working capital) + non-current assets – non-current liabilities ( = residual net assets or equity).

* (current assets should come first before non-current assets)

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Statement of Comprehensive Income

• Statement of Comprehensive Income is a structured financial statement that shows the financial performance of a business entity for a given period.

Methods of Presenting the Expenses

• Nature of expense method – expenses are aggregated in the statement according to their nature.

• Function of expense or cost of sales method – classifies expenses according to their function as part of cost of sales; distribution or selling; general or administrative activities; or other expenses.

- depends on historical and industry factors and the nature of the entity

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Statement of Changes in Equity

• Statement of Changes in Equity is a statement that reflects all the elements that caused changes in an entity’s equity between two dates of the statement of financial position. It shows the events and transactions that took place during a reporting period that affect equity.

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• Statement of Changes in Equity is a financial statement showing the following:

a. The total comprehensive income for the period showing separately the amounts due to owners of the parent and to non-controlling interests

b. For each component of equity, the effect of any retrospective restatement as a result of change in accounting policy or correction of prior period errors

c. For each component of equity, a reconciliation of the carrying amount at the beginning and at the end of the period, separately disclosing changes resulting from:

a. Net income or loss for the period

b. Each item of income and expense for the period that is recognized directly in equity and the total of these items

c. Transactions with owners in their capacity as owners, showing separately contributions from and distribution to owners.

Equity

• Equity is the residual interest in the assets of the entity after deducting all its liabilities.

• The equity of the shareholders may be subclassified as follows: – Share capital – represents funds contributed by

shareholders

– Retained Earnings – represents the accumulated amount of net income or loss, errors of prior periods, dividend distributions, changes in accounting policy and other equity adjustments other than those arising from shareholders’ contributions.

– Reserves:

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Equity

– Reserves:

• Appropriation reserve – is a transfer of an amount from the retained earnings.

• Share premium – represents the excess amount contributed by the shareholders over the par value.

• Revaluation adjustment – represents the excess of the depreciated replacement cost or sound value of the revalued property, plant and equipment over the book value.

• Foreign currency translation reserve – arises from the translation of financial elements or transactions in foreign currency into the functional currency of an entity.

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Notes to Financial Statements

Objectives of Notes to FS

• The Notes shall: a. Present information about the basis of preparation of

the financial statements and the specific accounting policies used;

b. Disclose the information required by IFRS that is not presented on the face of the statement of financial position, statement of comprehensive income, statement of changes in equity, or statement of cash flows; and

c. Provide additional information that is not presented on the face of the financial statements, but is relevant to an understanding of any of them.

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Structure of Notes

• Notes are normally presented in the following order: 1. A statement of compliance with IFRS 2. A summary of significant accounting policies applied 3. Supporting information for items presented on the

face of the statement of financial position, statement of comprehensive income, statement of changes in equity, or statement of cash flows, in the order in which each statement and each line item is presented; and

4. Other disclosures, including 1. Contingent liabilities and unrecognized contractual

commitments; and 2. Non-financial disclosures (entity’s financial risk

management objectives and policies)

conceptual framework of accounting

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