Conceptual Framework – terms and concept for presentation of FS for external users

- theoretical foundation of accounting

Contribute to transparency, strengthen accountability, and economic efficiency

Purpose

 Assist IASB to develop IFRS

 Assist to develop new accounting policy to the events not yet addressed
 Assist if the company has accounting policy choices
 Assist to understand and interpret the IFRS Standards

NOTE* if there is IFRS then it must be followed than Conceptual Framework

NOTE* Conceptual Framework Cannot overwrite IFRS but IASB can use it to rewrite the IFRS

Financial Reporting – communicating the set of financial statement and other financial information

PRIMARY USERS – Financial information is directly

 Existing and potential investors – risk and return

 Lenders and other creditors

OTHER USERS - Financial information is not directly

 Employees – stability and profitability of the company; renumeration (salary)

 Government and their agencies – allocation of resources and regulate activities
 Public – give trends

SCOPE OF REVISED CONCEPTUAL FRAMEWORK

1. OBJECTIVE OF FINANCIAL REPORTING- foundation

- provide financial information to users

- why of accounting

- financial information through annual financial statement

- financial reporting not only encompasses financial statement but also

 Financial highlights – standard format (table); overview of financial statements

 Summary of Important Financial Figures – more flexible; overview of financial statements
 Analysis of financial statements and significant ratio - examining and interpreting a company's
financial statements
 Other nonfinancial information

Specific objective of financial reporting

- To provide information

1. useful in decision making

2. to assess the cash flow

3. entity resources (asset) and claims (liability and equity) and changes on it

- financial position - income and comprehensive income

Liquidity – meet its short-term obligations

Solvency - meet its long-term obligations

Useful of Financial Performance

- information about return

- past financial performance predicts future returns

- generate future cash inflows from operations

Accrual Basis of Accounting

“accrual accounting means that income is recognized when earned regardless of when received and
expenses is recognized when incurred regardless of when its paid”

- basis for past and future performance

- most common

Limitations

 Cannot provide all information; primary users is need to consider pertinent (relevant)
information
 Not the value of an entity but estimate the value of the entity
 Cannot accommodate for every request for information so, they provide common info
 Doesn’t have exact depiction and only based on estimate and judgement

NOTE* Management Stewardship – how management manage their company

- Predicting how management use resources for future net cash flow

CHAPTER 3

2. QUALITATIVE CHARCTERISTICS

- qualities what makes financial information useful

A. Fundamental Qualitative Characteristics

- content of financial information

1. Relevance
2. Faithful Representation

Relevance and Faithful Representation

Application

1. identify economic phenomenon that is potential usefulness

2. identify information that is most relevant and can be faithfully represented

3. if the information is available

Relevance – influence a decision

- related

Statement of Financial Position - Financial Position

Income Statement – relevant of determining performance

NOTE* Earning per share is better then Book value per share in attractiveness of an investment

Ingredients of Relevance

 Predictive Value – current financial information can determine future outcome of events

NOTE* Financial Position predicts dividends and wage payments and maturing commitment

NOTE* NET CASH

 Confirmatory Value – feedback about previous evaluations

- confirm or correct expectations

Materiality – mistake that affects economic decision

a.k.a doctorine of convinence - professional judgment in applying accounting standards

NOTE* if the mistake is small, it’s irrelevant

- quantitative threshold

- relative size than absolute size

AISB definition

Could reasonable be expected to influence

- limited to the economic decision of primary users

- include in financial statements

Obscuring information

- not understand or not clearly expressed

a) Languagex
b) Info is scatter
c) Dissimilar items are combined
d) Similar items are not combined

Primary Users
Factors

Magnitude (relative size) and nature

Size of the item – total of the group to which item is belong (e.g. Cash in Current Asset)

Nature of the item – transaction is material (e.g. X company loans Y in unusual term)

Faithful Representation

- kind of transaction match the quantitative informative

Ingredients of Faithful Representation

 Completeness

- All information must be understand and avoids erroneous implication

Notes to Financial Statements

- necessary disclosure required by PFRS

Standard of adequate disclosure

- results in completeness

-all significant and relevant information shall be reported

- disclosure of financial facts significant enough to influence judgements of users

 Neutrality

- no bias

- free from bias

- to be neutral is to be fair

- Objectivity

- common needs of users

Prudence

- exercise of care and caution in dealing uncertainties

- Neutrality supports exercise of prudence

Conservatism

- synonymous with prudence

- least effect on equity

- “in case of doubt, record any loss and do no record any gain”

- e.g. Inventory cost is either 10,000 or 20,000. Then record the least cost
- not always required since it may cause fraud

Contingent loss- prepared in advance (provision)

Contingent gain – not recognized but disclose only (the expected gains is not added in the amount but
noted or disclose)

 Free from error

- no errors or omission in description of transactions

- estimate is faithful if the amount is clearly and accurate and explain

- if there is an error, this does not always result in material

Measurement Uncertainty

- cannot be observed and must be estimated

- affect faithful representation if there is high estimate

- estimate is faithful if the amount is clearly and accurate and explain even high level of measurement
uncertainly

Substance over Form

- Transaction must record in substance (economic substance) not in legal form

E.g. Y company purchase a truck worth 12,000 with monthly installments.

Analysis:

Substance: on the first transaction he become an owner

Legal form: the day the 12 monthly installment is finished, Y company become an owner

B. Enhancing qualitative characteristic

- increase the usefulness

1. Comparability
2. Understandability
3. Verifiability
4. Timeliness

Comparability

- likeness (similarities) and differences

Comparability within an entity – comparison of one accounting period vs another period

- a.k.a. horizontal comparability or intracomparability

Comparability between and across entity – comparison between entities in the same industry

- a.k.a. intercomparability or dimensional comparability

Consistency

- use of same accounting method from period to period

NOTE* Comparability is a goal and Consistency helps to achieve that goal

NOTE* Changing an accounting standard to better alternative must be made and must be full disclosure

NOTE* Not changing accounting policies is inappropriate

Understandability

- comprehensible (language) and intelligible (meaning of information)

- easily understand by the user

NOTE* realistically not everyone can understand the financial statements

Verifiability

- consensus (agreement of a group)

- supported by evidence

- duplicated by measurers (accounting department or teams like internal audit is need for verifiability)

- arm’s length transaction

- Principle of Objectivity

Direct Verification – direct observation (e.g. counting cash)

Indirect Verification - Evaluating information through secondary evidence (e.g. review documentation)

Timeliness

- Financial Information must be communicated early enough when decision is to be made

- Most important attribute in interim financial information

NOTE* the older the info, the less useful

- Past can be used in future

C. Cost constraint on useful information

- pervasive constraint- gathering information comes at cost

E.g. X company decide to issue annual financial statement and not quarterly to reduce cost

NOTE* benefit should exceed cost

- Judgmental process- decision is based on professional judgement

CHAPTER 4

3. GENERAL OBJECTIVE OF FINANCIAL STATEMENT

a. assessing future cash flow

b. assessing management stewardship

1. Statement of Financial Position

2. Income Statement
3. Statement of Cash Flow
4. Statement of Changes in equity
5. Notes to financial statements

Types of Financial Statements

1. Consolidated financial statements – parents and subsidiary

2. Unconsolidated financial statements – only parent

3. Combined Financial Statements – 2 or more entities not linked by parents and subsidiary relationship

Consolidated Financial Statements

Parent – has control over other company or subsidiary company

Primary users

- subsidiary creates own FS then combine it to parent company

Unconsolidated financial statements

- primary users

- not sufficient to meet the needs of the primary users

- cannot be a substitute if consolidated FS is required

NOTE* Claim to parent does not give claim to subsidiary

Combined Financial Statements

- Combining 2 separate entities own by one person or company

Reporting Entities

- prepares financial statements

- Not a legal entity

Whom to prepares?
1. Corpo, partnership, and sole proprietorship

2. parent only

3. parents and subsidiary as one entity

4. 2 or more entity as one entity (combined financial statement)

5. reportable business segments of an entity ( more than 10% of total asset, revenue, and expenses )

Reporting Period

Interim Financial Statement- optional and not required

Annual Financial Statement – required

NOTE* Required Comparative Information at least from preceding period

NOTE* Transaction after end of reporting period may reported if necessary (e.g. sale of asset)

Any subsequent event happen before official issuance date must be record & disclose ( 75-120 day
range after year-end )

Underlying Assumptions

Accounting Assumptions – foundation of accounting

- enhance understanding and usefulness of FS

NOTE* Only one Assumption is Going Concern

Basic Accounting Assumption

1. Accounting Entity

2. Time Period

3. Monetary Value

Going Concern or Continuity Assumption

- Continuing in operation indefinitely

- Foundation of Cost Principle or historical cost principle

- asset is recorded at cost and liabilities recorded at amount expected to pay

- if the business will be terminated, the assumption is abandoned

Accounting Entity – type of business organization (sole, proprietorship, partnership, and corporation )

-Business is separate from owner

- fair presentation of financial statements

- different business is independent accounting entity

-consolidated FS is treated as single economic entity

Time Period

- indefinite life of an entity is subdivided into accounting periods

Calendar year and Natural Business Year

Monetary Unit

1. Quantifiability

2. Stability of Peso

Quantifiability – unit of measure is “peso” in the Philippines

Stability of the Peso- value of peso does not change

- revaluation model – to adjust in case of inflation

CHAPTER 5

ELEMENTS OF FINANCIAL STATEMENTS

- broad classes

- quantitative information

- building blocks to financial statement

- financial position and income statement

- process of classification and subclassification

NOTE* no elements in statement of changes in equity

Essential Characteristic of Asset

1. present economic resources

2. Economic resources is a right to produce economic benefit

3. Controlled by entity as a result of past events

Right

1. Rights to an obligation of another entity. Right to receive

a) Cash
b) Goods or Service
c) Exchange economic resources with other party on favorable term (e.g. buying in bundle to
reduce cost
d) Benefit from an obligation of another party if a specified uncertain future event occurs (e.g.
insurance, repairs to new equipment)
2. Rights that are not obligation of another entity. Right to

a) Physical Object
b) Intellectual Property

3. Rights establish by contract

Potential to Produce economic Benefit

NOTE* For the Potential to exist, the right must already exist

- even if the economic benefit is low, it can be right

- present right and future benefits of right is uncertain

a) Receive Contractual Cash Flow

b) Exchange economic resources with other party on favorable term (e.g. buying in bundle to
reduce cost
c) Produce Cash Inflow and Not Cash Outflows
d) Receive Cash by Selling Economic Resources
e) Reduce Liability

Control of an economic resource

- control assets if it has present ability to obtain economic benefit

- arise when entity enforce legal right

- prevent others from using your asset

NOTE* Control can still exist without legal right as long as entity has a way of ensuring it (e.g.
Knowledge)

LIABILITY

a) Has an Obligation
b) obligation to transfer economic resource
c) present obligation that exist as a result of past event

NOTE* recognized until it is incurred

NOTE* NOT the ultimate outflow

Obligation

- responsibility that the entity cant avoid

Obligation is legal- contract or statutory requirement (obligation in government e.g. taxes)

Constructive Obligation – normal business practice (not written)

Transfer Economic Resource

 a) pay cash
b) deliver goods or noncash resources
c) providing service in future (Accrued Revenue)
d) exchange of economic resources with other party on unfavorable terms (accidents) (current)
e) transfer of economic resources if uncertain in future

Past event

a) already obtained economic benefits

b) transfer of an economic resources

INCOME

- both revenue and gains

Revenue- ordinary regular activity

- essence is regularity

Gains – do not arise from ordinary regular activity

Statement of Financial Performance

- income and comprehensive income

NOTE* The report may be recycle for another reporting period as long it results to relevant and faithful
represented

EXPENSE

- loss and ordinary regular activities

Loss – do not arise from ordinary regular activity

CHAPTER 6

RECOGNITION AND MEASUREMENT

Recognition – process of capturing for inclusion in the financial statement (elements)

NOTE* Asset, liability, equity recorded as carrying amount

- linked (recognized in one statement require recognition in another) one element affects another

- Recognized only if it is relevant and faithfully represented

- do not focus on how probable economic benefits will flow

- an element can exist even the benefits is low

Recognition Links – for every transaction there is an opposite effect

Income Recognition

- recognized when earned

- legal title pass to buyer at point of sale

Production Method – recognizing income at the point of or during production (overstated income and
not commonly use)

During Production- while happening the income is recognized

Point of Production – when production is done, the income is recognized

Cash basis of accounting- income is recognized when cash is received

NOTE* Accrual basis of accounting is commonly used

NOTE* According to IFRS, cash basis is prohibiting to used in most of the business

Expense Recognition

Matching Principle - expenses should be matched to the revenue they helped generate, regardless of
when the cash is actually paid or received. It is a concept that guides Accrual Basis of Accounting

- No pain, no gain (no expense, no revenue)

a) Cause and Effect Association

b) Systematic and rational allocation
c) Immediate Recognition

NOTE* both expense and income is reported in the same period

Cause and Effect Association

- expense is recognized when revenue is already recognized

- actual strict matching concept

- matching process – matching of cost(expense) with revenue

- best example is cost of merchandise inventory

Systematic and rational allocation

- cost are expensed by allocating them in different accounting period when economic benefit arises from
different time period

- example is depreciation

Immediate Recognition

a) Expenditure produces no future benefit (loss in fire, etc.)

b) Cost incurred does not qualify for an asset (supplies expense)
Derecognition

- removal of an asset or liability in the SFP

Measurement

- quantifying in monetary terms

a) Historical Cost
b) Current Value

Historical Cost

Initially – Historical Cost which is current value ; Subsequently – Amortized Cost

- readily verifiable

- most commonly use

- cost upon acquiring an asset

- cost of liability before interests

- entry price or entry value

Amortized Cost- intangible asset with lifespan

- Estimate of future cash flows (how much you will benefit from useful life)

- Discounted at a rate (todays money is worth more than futures money)

- same formula as depreciation

Historical Cost Updated

In terms of asset

a) Depreciation and amortization

b) Payment received in exchange of asset
c) Impairment
- loss due to fire and etc.
- Carrying Value – Fair Market Value = impairment loss (expense)

d) accrual interest revenue

e) Amortization cost measurement in financial asset like bonds

In terms of liability

a) Payment made
b) Increase in value of liability that it becomes onerous
c) Accrual Interest expense
d) Amortization cost measurement in financial liability like bonds

Current Value

a) Value in use for asset

 b) Fair Value
c) Fulfillment value for liability
d) Current Cost

Fair Value

- Price of an asset in the market

- value of liability upon payment due to changes like interest

- exit price or exit value

NOTE* if FMV cannot be determined then present value of cash flow is used

NOTE* FV is not adjusted for transaction cost (freight in in expense and not asset and liability)

Value in use

- present value of cash flow

- how much is the usefulness of an asset

- does not record transaction cost in acquiring

- record the transaction cost on the disposal of the asset

PV= CE / (1+r) ^ n

FV=PV × (1+r) ^ n

 PV = Present value of the cash flow

 CF = Cash flow amount

 r = Discount rate (interest rate)

 n = Number of periods (time)

- exit price or exit value

Fulfillment Value

- present value of the cash flows that an entity expects to incur as it fulfils a liability

- Settlement value is used acc. To IFRS than to Fulfillment Value

- exit price or exit value

Current Cost – have transaction cost

Of an Asset- cost of an asset at measurement date including transportation cost (replacement cost)

Of a Liability

- not applicable in depreciation

- entry price or entry value

Selecting a measurement basis

- nature of information

- no single factor to determine which one to use (IASB)

- historical cost

- simple and cheaper than to measure current value

- well understood and verifiable

CHAPTER 7

PRESENTATION AND DSICLOSURE AND CONCEPT OF CAPITAL

Presentation and disclosure

- effective communication tool

- More relevant and faithful representation

- enhance comparability and understandability

NOTE* Duplication is unnecessary and result in less understandable

Classifying

- sort the elements of FS based on similarities

- Current and Non-Current

NOTE* dissimilar items result in less relevant, comparability, understandability and no faithful rep

- components of equity is disclose separately

Classification of income and expense

Other comprehensive income- income and expense items that are not included in the main profit and
loss (P&L) statement.

Foreign currency translation adjustments

Revaluation gains/losses

original cost - fair market value of an asset

Aggregation- (summarize)

- adding together the ALORE in the same classification

- useful by summarizing a large volume of details

- conceal some details

Traditional Approach- traditional preparation of income statement

Capital Maintenance Approach- net income can only occur if the beginning capital is meet

-a.k.a. net worth method of measuring profit

Formula for inflation

Capital Investment + inflation percentage = inflation-adjusted cost of capital

Net income > Inflation-adjusted cost of capital MEANS maintains capital

Net income - Inflation-adjusted cost of capital= true increase in purchasing power

Return on Capital – percentage of profit or income generated from invested capital

= Net income / Invested Capital * 100

Return of Capital – return or erosion of your original investment.

Financial Concept- nominal monetary unit

- does not required measurement basis

Physical Concept- operating capability

- there is profit if physical productive capacity end > beg

Price changes treat as capital maintenance adjustment

Physical Capital Maintenance Approach – correct cost