CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

Lesson 2: PAS 1 – Presentation of Financial Statements

PAS 2 – Inventories
Lesson Objectives:
1. Enumerate and describe the general features of financial statement presentation; the
components of a complete set of financial statements; state the acceptable methods of
presenting items of income and expenses; differentiate between the statement of
profit or loss and other comprehensive income and the statement of changes in equity;
and state the relationship of the notes with the other components of a complete set of
financial statements.
2. Define and measure inventories and apply the cost formulas. State the accounting for
inventory write-down and the reversal thereof.

Discussion:
Lesson 2.1 PAS 1 - Presentation of Financial Statements
Philippine Accounting Standard (PAS 1) or IAS 1 prescribes the basis for the presentation of
general purpose financial statements, guidelines for their structure and minimum requirements
for its content to ensure intra (same entity but of different period) and inter (different entities
in the same line of business) comparability.

- Main components of financial statements:

o Statement of financial position
o Statement of profit or loss and other comprehensive income
o Statement of changes in equity
o Statement of cash flows
o Notes to the financial statements
- General features of financial statements:
o Fair presentation and compliance with PRFS
 Needs to make an explicit and unreserved statement of such
complian in the notes to financial statements.
 Permits departure from a PFRS requirement if the relevant regulatory
framework requires or allows such departure. The entity needs to
disclose such PFRS departure, its effects and regulatory body which
allows it (e.g. Bangko Sentral ng Pilipinas, etc.).
 Requires proper selection and application of accounting policies,
presentation and disclosures. Note that inappropriate accounting
policies cannot be rectified by mere disclosures.
o Going concern as mentioned in Lesson 1 unless the entity has an intention to
liquidate.
o Accrual basis of accounting
o Materiality and aggregation
o Offsetting
o Frequency of reporting, which should at least be annually. However, if the
entity changes its reporting period, disclosures are needed as to:
 The new accounting period
 Reason
  Fact that amounts presented in the financial statements are not
entirely comparable.
o Comparative information of at least two periods
o Consistency of presentation
- Structure and content of financial statements
o Name of reporting entity
o Whether the statements are for the individual entity or for a group of entities.
o The date of the end of the reporting period or for the period covered
o Presentation currency
o Level of rounding off used
- The management’s responsibilities over financial statements are expressly stated in
the Statement of Management’s Responsibility for Financial Statements signed by the
chairman of the board, chief executive officer and chief financial officer or their
equivalents and attached in the financial statements as a cover letter. Such
responsibilities are:
o Preparation and fair presentation in accordance with PFRSs
o Internal control over financial reporting
o Going concern assessment
o Oversight over the financial reporting process
o Review and approval

Statement of Financial Position

- Statement of financial position shows the financial condition as at a certain date

although it does not prescribe the order or format as to how it should be presented.
- The entity may also modify its descriptions to suit the nature of the entity and its
transactions. It does not prescribe the order or format as to how it should be
presented.
- It may be presented as classified (which shows distinction between current and non-
current, applying the 12-month rule), unclassified (based on liquidity only normally
used by financial institutions) and mixed (or combination of both).
- It includes the following line items,:
o Property, plant and equipment
o Investment property
o Intangible assets
o Financial assets (excluding item just below this, trade and other receivables
and cash and cash equivalents
o Investments accounted for using the equity method
o Biological assets
o Inventories
o Trade and other receivables
o Cash and cash equivalents
o Assets held for sale, including disposal groups
o Trade and other payables
o Provisions
o Financial liabilities excluding the 2 items above this
o Current tax liabilities and current tax assets
o Deferred tax liabilities and deferred tax assets
o Liabilities included in disposal groups
o Non-controlling interests
o Issued capital and reserves attributable to owners of the parent
 - Refinancing (replacement of an existing debt with a new one but with different terms)
agreement of a non-current liability:
o Previously reported long-term obligation maturing is 12 months after the
reporting period is classified as current liability (applying the 12-month rule)
o If refinancing agreement to reschedule payments for more than one year is
completed after the reporting period, but before the financial statements are
authorized for issue, it is still classified at current liability.
o If refinancing agreement to reschedule payments for more than one year is
completed before the reporting period, it is still classified at non-current
liability.
o If the entity has the discretion to refinance it on a long-term basis under an
existing loan facility, it is classified as non-current liability
o If the entity has no discretion to refinance it on a long-term basis (no
arrangement for refinancing), it is classified as current liability
o Similar rule applies in case of breached of condition of its loan agreement:
 It is classified as current liability if any of the conditions is not met.
 If lender agrees not to enforce payment after the end of the reporting
period and before financial statements are authorized for issue, it is
still classified as current liability.
 If lender agreed on or before the end of the reporting period to
provide a grace period of at least 12 months to rectify the breach, the
lender cannot demand payment, the liability is classified as non-
current.
Statement of Profit or Loss and Other Comprehensive Income

- It is the most significant indicator of the financial performance of the entity. PAS/IAS
1 stipulates that all items of income and expense shall be included in the statement.

- Income and expense items can be presented either

o In a single statement of profit or loss and other comprehensive income
o In two statements:
 Statement of profit or loss
 Statement of other comprehensive income
- Line items in the profit or loss section:
o Revenue, presenting separately interest revenue
o Finance costs
o Gains and losses arising from derecognition of financial assets measured at
amortized cost
o Impairment losses and impairment gains on financial assets
o Gains and losses on reclassifications of financial assets from amortized cost
or fair value through other comprehensive income through fair value through
profit or loss
o Share in the profit or loss of associates and joint ventures
o Tax expense
o Results of discontinued operations
- Methods of presentation of expenses
o Nature of expense method
o Function of expense or cost of sales method
- Components of other comprehensive income
o Changes in revaluation surplus
o Remeasurements of the net defined benefit liability (asset)
o Gains and losses on investments designated or measured at fair value through
other comprehensive income (FVOCI)
 o Gains or losses arising from translating the financial statements of a foreign
corporation
o Effective portion of gains or losses on hedging instruments in a cash flow
hedge
o Changes in fair value of a financial liability designated at fair value through
profit or loss (FVPL) that are attributable to changes in credit risk
o Changes in the time value of option when the option’s intrinsic value and
time value are separated and only the change in intrinsic value is designated
as the hedging instrument
Changes in the value of the forward elements of a forward contracts when separating the
forward element and spot element of a forward contract

- Presentation of other comprehensive income:

o Reclassification adjustment is allowed
 Gains and losses on investments of debt instrument designated or
measured at fair value through other comprehensive income
(FVOCI)
 Gains or losses arising from translating the financial statements of a
foreign corporation
 Effective portion of gains or losses on hedging instruments in a cash
flow hedge
 May be presented either at net or gross of tax.
o Reclassification adjustment is not allowed
 Changes in revaluation surplus
 Remeasurements of the net defined benefit liability (asset)
 Gains and losses on investments of equity instrument designated or
measured at fair value through other comprehensive income
(FVOCI)
- Reclassification adjustments are amounts reclassified to profit or loss in the current
period that were recognized in other comprehensive income in the current or previous
periods.

Statement of Changes in Equity

- Shows the following:

o Effects of changes in accounting policy or correction of prior period error.
o Total comprehensive income income for the period
o For each component of equity, a reconciliation between the carrying amount
at the beginning and the end of the period showing separately changes
resulting from:
 Profit or loss
 Other comprehensive income
 Transactions with owners (contributions by and distributions to
owners)

Notes to Financial Statements

- It is an integral part of a complete set of financial statements which financial

information should be cross-referenced to the notes as it will amplify information
shown therein:
o More detailed analysis or breakdowns of figures in the statements
o Narrative information explaining figures in the statements
o Additional information (e.g. contingent liabilities and commitments)
- Functions of notes to financial statements:
 o Present information about the basis on which the financial statements were
prepared and which specific accounting policies were chosen and applied to
significant transactions/events.
o Disclose any information not shown elsewhere in the financial statements
which is required by PFRSs
o Show any additional information that is relevant to understanding which is
not shown elsewhere in the financial statements.
- Order as suggested by PAS 1:
o Statement of compliance with PFRSs
o Statement of measurement bases and accounting policies applied
o Supporting information for items presented in each financial statement in the
same order as each line item and each financial statement is presented.
o Other disclosures:
 Contingent liabilities, commitments and other financial disclosures
 Non-financial disclosures
- Disclosures of accounting policies
o The measurement basis used
o Other accounting policies used
- Other disclosures:
o The amount of dividends proposed or declared before the financial statements
were authorized for issue but not recognized as a distribution to owners
during the period and the amount per share.
o The amount of any cumulative preference dividends not recognized
- Specific disclosures which will always be required
o The domicile and legal form of the entity, its country of incorporation and the
address of the registered office.
o A description of the nature of the entity’s operations and its principal
activities
o The name of the parent entity and the ultimate parent entity of the group.

Lesson 2.2 PAS 2 - Inventories

This lays out the required accounting treatment for inventories. Inventories are assets
held for sale in the ordinary course of business, in the process of production for such sale or in
the form of materials or supplies to be consumed in the production process or in the rendering
of services.

- Inventories include
o Goods purchased and held for resale
o Finished goods produced
o Work in progress being produced
o Materials and supplies awaiting use in the production process
- Inventories should be measured at the lower of cost and net realizable value.
 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.
 Costs may exceed the NRV (obsolete or damaged goods), which
should be written down to NRV, which is recognized as expense.
 If NRV subsequently increases, the previous write-down should be
reversed provided it will not exceed the original write-down.
 Write-downs of inventories are usually carried out on an item by item
basis
  Raw materials inventory is not written down below cost if finished
goods in which they will be a part of are expected to be sold at or
above cost. Otherwise, the raw materials are written down to NRV or
its replacement cost.
- Cost of inventories will consist of:
o All costs of purchase (purchase price, import duties and other taxes,
transport, handling and other cost directly attributable to the acquisition of
finished goods, services and materials net of discounts, rebates and other
similar amounts)
o Cost of conversion (cost directly related to the units of production like direct
materials and direct labor and fixed and variable production overhead)
o Other costs incurred in bringing the inventories to their present location and
condition.
- The following costs are excluded from the cost of inventories and are expensed
outright
o Abnormal amounts of wasted materials, labor or production costs
o Storage costs unless it is necessary in the production process.
o Administrative overhead
o Selling costs
- Cost formulas deal with the computation of cost of inventories
o Specific identification – used for inventories that are not ordinarily
interchangeable.
o First-in, First-out – it is assumed that inventories that were purchased or
produced first are sold first.
o Weighted average – determined on the weighted average cost of beginning
inventory and all inventories purchased or produced during the period.
- Techniques for the measurement of cost which approximate to cost which may be
used for convenience:
o Standard costs – are set up to take account of normal production values which
are reviewed and revised on a regular basis.
o Retail method – is often used in the retail industry where there is a large
turnover of inventory items which have similar profit margins
- Disclosures
o Accounting policies adopted in measuring inventories including the cost
formula used
o Total carrying amount of inventories and the carrying amount in
classifications appropriate to the entity
o Carrying amount of inventories carried at fair value less cost to sell
o Amount of inventories recognized as an expense during the period
o Amount of any write-down recognized as an expense in the period
o Amount of any reversal of write-down that is recognized as a reduction in the
amount of inventories recognized as expense in the period
o Circumstances or events that led to the reversal of a write-down of
inventories
o Carrying amount of inventories pledged as security for liabilities.