CHAPTER 1

OVERVIEW OF ACCOUNTING

Objectives:
Define the meaning of accounting
Identify and learn the PAS 1 to PAS 23

Definition of Accounting

Accounting is “the process of identifying, measuring, and

communicating economic information to permit informed judgment and
decisions by users of information.”

Three important activities

1. Identifying - the process of analyzing events and transactions to

determine whether or not they will be recognized. Only
accountable events are recognized.

2. Measuring - involves assigning numbers, normally in monetary

terms, to the economic transactions and events.

3. Communicating - the process of transforming economic data into

useful accounting information, such as financial statements and
other accounting reports, for dissemination to users.

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Types of Events

1. External events – events that involve an external party.

a. Exchange (reciprocal transfer) – reciprocal giving and receiving

b. Non-reciprocal transfer – “one way” transaction

c. External event other than transfer – an event that involves

changes in the economic resources or obligations of an entity
caused by an external party or external source but does not
involve transfers of resources or obligations.

2. Internal events – events that do not involve an external party.

a. Production – the process by which resources are transformed into

finished goods.

b. Casualty – an unanticipated loss from disasters or other similar

events.

Measurement

The several measurement bases used in accounting include, but not

limited to, the following:

- historical cost,

- fair value,

- present value,

- present value,

- current cost, and

- sometimes inflation-adjusted costs.

The most commonly used is historical cost. This is usually combined

with the other measurement bases. Accordingly, financial statements are
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 said to be prepared using a mixture of costs and values

Types of accounting information classified as to users’ needs

1. General purpose accounting information - designed to meet the

common needs of most statement users. This information is governed
by the Philippine Financial Reporting Standards (PFRSs).

2. Special purpose accounting information - designed to meet the specific

needs of particular statement users. This information is provided by
other types of accounting, e.g., managerial accounting, tax basis
accounting, etc.

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- Double-entry system – each accountable event is recorded in two
parts – debit and credit

- Going concern - the entity is assumed to carry on its operations

for an indefinite period of time.

- Separate entity – the entity is treated separately from its owners,

- Stable monetary unit - amount in the financial statements are

stated in terms of a common unit of measure; changes in
purchasing power are ignored.

- Time Period – the life of the business is divided into series of

reporting periods.

- Materiality concept – information is material if its omission or

misstatement could influence economic decisions.

- Cost-benefit – the cost of processing and communicating

information should not exceed the benefits to be derived from it

- Accrual Basis of accounting – effects of transactions are

recognized when they occur (and not as cash is received or paid)
and they are recognized in the accounting periods to which they
relate

- Historical cost concept – the value of an asset is determined on

the basis of acquisition cost.

- Concept of Articulation – all of the components of a complete set

of financial statements are interrelated.

- Full disclosure principle – financial statements provide sufficient

detail to disclose matters that make a difference to users, yet
sufficient condensation to make the information understandable,
keeping in mind the costs of preparing and using it.
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 - Consistency concept – financial statements are prepared on the
basis of accounting policies which are applied consistently from
one period to the next.

- Matching – costs are recognized as expenses when the related

revenue is recognized.

- Residual equity theory – this theory is applicable where there are

two classes of shares issued, ordinary and preferred. The
equation is “Assets – Liabilities – Preferred Shareholders’ Equity
= Ordinary Shareholders’ Equity.”

- Fund theory – the accounting objective is the custody and

administration of funds

- Realization – the process of converting non-cash assets into cash

or claims for cash

- Prudence (Conservatism) – the inclusion of a degree of caution in

the exercise of the judgments needed in making the estimates
required under conditions of uncertainty , such that assets or
income are not overstated and liabilities or expenses are not
understated

Common branches of accounting

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1. Financial accounting - focuses on general purpose financial statements

2. Management accounting – focuses on special purpose financial reports

for use by an entity’s management.

3. Cost accounting - the systematic recording and analysis of the costs of

materials, labor, and overhead incident to production.

4. Auditing - the process of evaluating the correspondence of certain

assertions with established criteria and expressing an opinion thereon

5. Tax accounting - the preparation of tax returns and rendering of tax

advice, such as the determination of tax consequences of certain
proposed business endeavors

6. Government accounting - refers to the accounting for the government

and its instrumentalities, placing emphasis on the custody of public
funds, the purposes for which those funds are committed, and the
responsibility and accountability of the individuals entrusted with those
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 funds.

Four sectors in the practice of accountancy

1. Practice of Public Accountancy - involves the rendering of audit or

accounting related services to more than one client on a fee basis.

2. Practice in Commerce and Industry - refers to employment in the private

sector in a position which involves decision making requiring
professional knowledge in the science of accounting and such position
requires that the holder thereof must be a CPA.

3. Practice in Education/Academe – employment in an educational

institution which involves teaching of accounting, auditing, management
advisory services, finance, business law, taxation, and other technically
related subjects.

4. Practice in the Government – employment or appointment to a position

in an accounting professional group in the government or in a
government–owned and/or controlled corporation where decision
making requires professional knowledge in the science of accounting, or
where civil service eligibility as a CPA is a prerequisite

Conceptual Framework for Financial Reporting

The Conceptual Framework sets out the concepts that underlie the
preparation and presentation of financial statements for external users

Objective of general-purpose financial reporting

- The objective of general-purpose financial reporting is to provide

financial information about the reporting entity that is useful to
existing and potential investors, lenders and other creditors in
making decisions about providing resources to the entity. A
secondary objective of financial statements is to show the results

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 of the stewardship of management

- The objective of general-purpose financial reporting forms the

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

Users and their Needs

Primary users – those to whom general purpose financial reports are

directed:
(a) Existing and potential investors
(b) Lenders and other creditors

Only the common needs of primary users are met by the financial
statements

Qualitative Characteristics

1. Qualitative Characteristics

(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
(2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error
2. Enhancing qualitative characteristics

(3) Comparability

(4) Verifiability
(5) Timeliness
(6) Understandability

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Elements of Financial Statements
Financial Position
1. Asset - resource controlled by the entity as a result of past events and
from which future economic benefits are expected to flow to the entity.

2. Liability - present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity
of resources embodying economic benefits.

3. Equity – assets less liabilities

Performance

1. Income - encompasses both (a) revenues and (b) gains

2. Expense - encompasses both (b) expenses and (losses)

PAS 1 Presentation of Financial Statements

PAS 1 prescribes the basis for presentation of a general purpose

financial statements to improve comparability both with the entity's
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financial statements of previous periods (intra-comparability) and with
the financial statements of other entities (inter-comparability).

Complete set of financial statements

1. Complete set of financial statements

2. Statement of profit or loss and other comprehensive income

3. Statement of changes in equity

4. Statement of cash flows

5. Notes (5a) comparative information in respect of the preceding

period; and

6. Additional statement of financial position (required only when certain

instances occur)

General features

1. Fair Presentation and Compliance with PFRSs - The application of

PFRSs, with additional disclosure when necessary, is presumed to
result in financial statements that achieve a fair presentation

2. Going concern - An entity is not a going concern if, as of the financial

reporting date or prior to the date of authorization of the financial
statements for issue, management either:

a. Intends to liquidate the entity or to cease trading, or

b. Has no realistic alternative but to do so.

3. Accrual Basis of Accounting - An entity shall prepare its financial

statements, except for cash flow information, using the accrual basis
of accounting

4. Materiality & Aggregation - Each material class of similar items must

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 be presented separately in the financial statements.

5. Offsetting - Assets and liabilities, and income and expenses, shall not
be offset unless required or permitted by a PFRS

6. Frequency of reporting – An entity shall present a complete set of

financial statements (including comparative information) at least
annually

7. Comparative Information - An entity shall present comparative

information in respect of the preceding period for all amounts
reported in the current period’s financial statements, unless other
standards permit or require otherwise

8. Consistency of presentation - An entity shall retain the presentation

and classification of items in the financial statements from one period
to the next unless:

a. it is apparent that another presentation or classification would

be more appropriate following a significant change in the nature
of the entity’s operations or a review of its financial statements;
or

b. a PFRS requires a change in presentation

Statement of financial position

A statement of financial position may be presented as either

a. Classified - showing distinctions between current and

noncurrent assets and liabilities, or

b. Unclassified (based on liquidity) - showing no distinction

between current and noncurrent items

Current Assets

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An entity shall classify an asset as current when:
1. it expects to realize the asset or intends to sell or consume it, in
its normal operating cycle

2. it holds the asset primarily for the purpose of trading

3. it expects to realize the asset within twelve months after the

reporting period

4. the asset is cash or a cash equivalent unless the asset is

restricted from being exchanged or used to settle a liability for
at least twelve months after the reporting period

Current Liabilities

An entity shall classify a liability as current when:

1. it expects to settle the liability in its normal operating cycle

2. it holds the liability primarily for the purpose of trading

3. the liability is due to be settled within twelve months after the

reporting period

4. 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 Deferred taxes

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 Deferred tax liabilities (assets) are presented as noncurrent items
in a classified statement of financial position, irrespective of their
expected dates of reversal

Statement of profit or loss and other comprehensive income

An entity shall present all items of income and expense recognized in a

period

1. in a single statement of profit or loss and other comprehensive

income

2. in two statements: (1) a statement displaying the profit or loss

section only (separate ‘statement of profit or loss’ or ‘income
statement’) and (2) a second statement beginning with profit or
loss and displaying components of other comprehensive
income

Total comprehensive income

Total comprehensive income comprises all components of Profit

or loss; and Other comprehensive income

Presentation of Expenses

1. Nature of expense method

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 2. Function of expense method

PAS 2 Inventories

Inventories are assets

1. Held for sale in the ordinary course of business (Finished

Goods)

2. In the process of production for such sale (Work In Process)

3. In the form of materials or supplies to be consumed in the

production process or in the rendering of services (Raw
materials and manufacturing supplies)

Financial statement presentation

All items that meet the definition of inventory are presented on the
statement of financial position as one line item under the caption
“Inventories.” The breakdown of this line item (as finished goods, WIP
and Raw materials) is disclosed in the notes

Inventories are normally presented in a classified statement of

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financial position as current assets

Measurement

a. Inventories are measured at the lower of cost and net

realizable value (NRV)

b. The cost of inventories comprise all costs of purchase, costs of

conversion and other costs incurred in bringing the inventories
to their present location and condition

c. Net realizable value (NRV) is the estimated selling price in the

ordinary course of business less the estimated costs of
completion and the estimated costs necessary to make the sale

Cost Formulas

1. Specific identification - - shall be used for inventories that are not

ordinarily interchangeable (i.e., used for inventories that are unique).
Cost of sales is the cost of the specific inventory that was sold

2. FIFO - cost of sales is based on the cost of inventories that were

purchased first. Consequently, ending inventory represents the cost
of the latest purchases

3. Weighted Average Cost - cost of sales is based on the average cost

of all inventories purchased during the period.

Wtd. Ave. Cost = (TGAS in pesos ÷ TGAS in units)

Recognition as an expense

The carrying amount of an inventory that is sold is charged as

expense (i.e., cost of sales) in the period in which the related revenue is
recognized. Likewise, the write-down of inventories to NRV and all
losses of inventories are recognized as expense in the period the write-

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down or loss occurs

For further discussion please refer to the link provided: Overview of Accounting
https://www.youtube.com/watch?v=RlhHMzzMKwA
For further discussion please refer to the link provided: Conceptual Framework
https://www.youtube.com/watch?v=CaGife7RCnE
For further discussion please refer to the link provided : PAS 1 – Presentation of FS
https://www.youtube.com/watch?v=c54-lIDFqbk

Reference Book:
Conceptual Framework and Accounting
Standards
By: Zeus Vernon B. Millan, 2019

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