CHAPTER 1 (THE ACCOUNTANCY PROFESSION) EXTERNAL AND INTERNAL TRANSACTIONS

DEFINITION OF ACCOUNTING Economic activities of an entity are referred to as

transactions which may be classified as external and
Accounting Standards Council internal.
-Accounting is a service activity.
-The accounting function is to provide quantitative External transactions or exchange transactions are those
information, primarily financial in nature, about economic economic events involving one entity and another entity.
entities, that is intended to be useful in making economic
decision. Examples of external transactions are:
a. Purchase of goods from a supplier
Committee on Accounting Terminology of the American b. Borrowing money from a bank
Institute of Certified Public Accountants c. Sale of goods to a customer
-Accounting is the art of recording, classifying and d. Payment of salaries to employees
summarizing in a significant manner and in terms of money, e. Payment of taxes to the government
transactions and events which are in part at least of a
financial character and interpreting the results thereof. Internal transactions are the economic activities that take
place entirely within the entity only. No other parties are
American Accounting Association in its Statement of Basic involved.
Accounting Theory
-Accounting is the process of identifying, measuring and Production and casualty loss are examples of internal
communicating economic information to permit informed transactions.
judgment and decision by users of the information.
Production is the process by which resources are
Important points transformed into products.
1. Accounting is about quantitative information.
2. The information is likely to be financial in nature. Casualty is any sudden and unanticipated loss from fire,
3. The information should be useful in decision making. flood, earthquake and other event ordinarily termed as an
act of God.
American Accounting Association. (stood the test of time)
-The definition states that the very purpose of accounting is MEASURING
to provide quantitative information to be useful in making an
economic decision. Measuring is the accounting process of assigning of peso
amounts to the accountable economic transactions and
The definition also states that accounting has a number of events. If accounting information is to be useful, it must be
components, namely: expressed in terms of a common financial denominator.
a. Identifying as the analytical component. Financial statements without monetary amounts would be
b. Measuring as the technical component. largely unintelligible or incomprehensible.
c. Communicating as the formal component.
The measurement bases are historical cost and current
IDENTIFYING value.

Identifying is the recognition or nonrecognition of business Historical cost is the original acquisition cost and the most
activities as "accountable" events common measure of financial transactions.
Current value includes fair value, value in use, fulfillment
Not all business activities are accountable. value and current cost.

For example, the hiring of employees, the death of the entity COMMUNICATING
president and the entering into a contract are all business
activities but such events are not accountable because Communicating is the process of preparing and distributing
such activities cannot be quantified or expressed in terms accounting reports to potential users of accounting
of a unit of measure. information.

An event is accountable or quantifiable when it has an effect Identifying and measuring are pointless if the information
on assets, liabilities and equity. contained in the accounting records cannot be
communicated in some form to potential users.
In other words, the subject matter of accounting is
economic activity or the measurement of economic Actually, the communicating process is the reason why
resources and economic obligations. accounting has been called the "universal language of
business"
Only economic activities are emphasized and recognized in
financial accounting. Implicit in the communication process are the recording,
classifying and summarizing aspects of accounting.
Sociological and psychological matters are beyond the
province of accounting.
Recording or journalizing is the process of systematically LIMITATION OF THE PRACTICE OF PUBLIC
maintaining a record of all economic business transactions ACCOUNTANCY
after they have been identified and measured.
Single practitioners and partnerships for the practice of
Classifying is the sorting or grouping of similar and public accountancy shall be registered certified public
interrelated economic transactions into their respective accountants in the Philippines.
classes. Classifying is accomplished by posting to the
ledger. A certificate of accreditation shall be issued to certified
public accountants in public practice only upon showing in
The ledger is a group of accounts which are systematically accordance with rules and regulations promulgated by the
categorized into asset accounts, liability accounts, equity Board of Accountancy and approved by the Professional
accounts, revenue accounts and expense accounts. Regulation Commission that such registrant has acquired a
minimum of three years of meaningful experience in any of
Summarizing is the preparation of financial statements the areas of public practice including taxation.
which include the statement of financial position, income
statement, statement of comprehensive income, statement The Securities and Exchange Commission shall not
of changes in equity and statement of cash flows register any corporation organized for the practice of public
accountancy.
OVERALL OBJECTIVE OF ACCOUNTING

The overall objective of accounting is to provide quantitative ACCREDITATION TO PRACTICE PUBLIC

financial information about a business useful to statement ACCOUNTANCY
users particularly owners and creditors in making economic
decisions. Certified public accountants, firms and partnerships of
certified public accountants, including partners and staff
Accounting is an information system that measures members are required to register with the Board of
business activities, processes information into financial Accountancy and Professional Regulation Commission for
reports and communicates the reports to decision makers. the practice of public accountancy.

An accountant's primary task is to supply financial The Professional Regulation Commission upon favorable
information so that the statement users could make recommendation of the Board of Accountancy shall issue
informed judgment and better decision. the Certificate of Registration to practice public
accountancy which shall be valid for 3 years and renewable
Financial reports tell us how well an entity is performing in every 3 years upon payment of required fees.
terms of profit and loss and where it stands in financial
terms. Certified Public Accountants generally practice their
profession in three main areas, namely:
THE ACCOUNTANCY PROFESSION
a. Public accounting
At present, Republic Act No. 9298 is the law regulating the b. Private accounting
practice of accountancy in the Philippines. This law is c. Government accounting.
known as the Philippine Accountancy Act of 2004.
PUBLIC ACCOUNTING
Accountancy has developed as a profession attaining a
status equivalent to that of law and medicine. The field of public accounting or public accountancy is
composed of individual practitioners, small accounting firms
In the Philippines, in order to qualify to practice the and large multinational organizations that render
accountancy profession, a person must finish a degree in independent and expert financial services to the public.
Bachelor of Science in Accountancy and pass a very
difficult government examination given by the Board of Public accountants usually offer three kinds of services,
Accountancy. namely auditing, taxation and management advisory
services.
The Board of Accountancy is the body authorized by law to
promulgate rules and regulations affecting the practice of As a matter of fact, large multinational accounting firms
the accountancy profession in the Philippines. have separate division for each of these services.

The Board of Accountancy is responsible for preparing and AUDITING

grading the Philippine CPA examination.
Auditing has traditionally been the primary service offered
This computer-based examination is offered twice a year, by most public accounting practitioners.
one in May and another one in October, in authorized
testing centers around the country. Auditing or external auditing is the examination of financial
statements by independent certified public accountant for
the purpose of expressing an opinion as to the fairness with
which the financial statements are prepared.
Actually, external auditing is the attest function of GOVERNMENT ACCOUNTING
independent CPAs.
Government accounting encompasses the process of
The Bureau of Internal Revenue requires audited financial analyzing, classifying, summarizing and communicating all
statements to accompany the filing of annual income tax transactions involving the receipt and disposition of
return. government funds and property and interpreting the results
thereof.
Banks and other lending institutions frequently require an
audit by an independent CPA before granting a loan to the The focus of government accounting is the custody and
borrower. administration of public funds.

Creditors and prospective investors place considerable Many Certified Public Accountants are employed in some
reliance on audited financial statements on making branches of the government, more particularly Bureau of
economic decision. Internal Revenue, Commission on Audit, Securities and
Exchange Commission, Bangko Sentral ng Pilipinas and
TAXATION even in a police agency National Bureau of Investigation.

Taxation service includes the preparation of annual income CONTINUING PROFESSIONAL DEVELOPMENT (CPD)
tax returns and determination of tax consequences of
certain proposed business endeavors. Republic Act No. 10912 is the law mandating and
strengthening the continuing professional development
The CPA not infrequently represents the client in tax program for all regulated professions, including the
investigations. accountancy profession.

To offer this service effectively and efficiently, the public All certified public accountants shall abide by the
accountant must be thoroughly familiar with the tax laws requirements, rules and regulations on continuing
and regulations and updated with changes in taxation law professional development to be promulgated by the Board
and court cases concerned with interpreting taxation law of Accountancy, subject to the approval of the Professional
Regulation Commission.
MANAGEMENT ADVISORY SERVICES
Continuing professional development is the acquisition of
Management advisory services have become increasingly advanced knowledge, skill and proficiency. Continuing
important in recent years although audit and tax services professional development raises and enhances the
are undoubtedly the mainstay of public accountants. technical skill and competence of the Certified Public
Accountant.
The term management advisory services has no precise
coverage but is used generally to refer to services to clients CPD CREDIT UNITS
on the following matters:
The CPD credit units refer to the CPD credit hours required
Advice on installation of computer system for the renewal of CPA license and accreditation of a CPA
Quality control to practice the accountancy profession every three years.
Installation and modification of accounting system
Budgeting Under the new BOA Resolution, all Certified Public
Forward planning and forecasting Accountants regardless of area or sector of practice shall
be required to comply with 120 CPD credit units.
PRIVATE ACCOUNTING
The Continuing Professional Development is required for
Many Certified Public Accountants are employed in the renewal of CPA license and accreditation of CPA to
business entities in various capacity as accounting staff, practice the accountancy profession.
chief accountant, internal auditor and controller.
The Continuing Professional Development has become
The highest accounting officer in an entity is known as the mandatory for Certified Public Accountants.
controller.
As recently promulgated, only 15 CPD credit units are
The major objective of the private accountant is to assist required for the renewal of CPA license
management in planning and controlling the entity's
operations. However, 120 CPD credit units are required for
accreditation of a CPA to practice the accountancy
Private accounting includes maintaining the records, profession.
producing the financial reports, preparing the budgets and
controlling and allocating the resources of the entity. Excess credit units earned shall not be carried over to the
next three-year period, except credit units earned for
masteral and doctoral degrees.
EXEMPTION FROM CPD Managerial accounting is the accumulation and preparation
of financial reports for internal users only.
A CPA shall be permanently exempted from CPD
requirements upon reaching the age of 65 years. However, In other words, managerial accounting is the area of
this exemption applied only to the renewal of CPA license accounting that emphasizes developing accounting
and not for the purpose of accreditation to practice the information for use within an entity.
accountancy profession.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
ACCOUNTING VERSUS AUDITING
Accounting has evolved through time changing with the
In a broad sense, accounting embraces auditing. Auditing needs of society. As new types of transactions occur in
is one of the areas of accounting specialization. trade and commerce, accountants develop rules and
procedures for recording them.
In a limited sense, accounting is essentially constructive in
nature. Accounting ceases when financial statements are These accounting rules, procedures and practices came to
already prepared. On the other hand, auditing is analytical, be known as generally accepted accounting principles or
The work of an auditor begins when the work of the simply GAAP.
accountant ends.
The principles have developed on the basis of experience,
After the financial statements are prepared, the auditor will reason, custom, usage and practical necessity.
begin to perform the task of auditing.
Generally accepted accounting principles represent the
The auditor examines the financial statements to ascertain rules, procedures, practice and standards followed in the
whether they are in conformity with generally accepted preparation and presentation of financial statements.
accounting principles.
Generally accepted accounting principles are like laws that
ACCOUNTING VERSUS BOOKKEEPING must be followed in financial reporting.

Bookkeeping is procedural and largely concerned with The process of establishing GAAP is a political process
development and maintenance of accounting records. which incorporates political actions of various interested
Bookkeeping is the "how" of accounting. Accounting is user groups as well as professional judgment, logic and
conceptual and is concerned with the why, reason or research.
justification for any action adopted.
ACCOUNTING STANDARDS
Bookkeeping is a procedural element of accounting as
arithmetic is a procedural element of mathematics. The generally accepted accounting principles are actually
the accounting standards required for the preparation and
ACCOUNTING VERSUS ACCOUNTANCY presentation of financial statements.

Broadly speaking, the two terms are synonymous because Accounting standards create a common understanding
they both refer to the entire field of accounting theory and between preparers and users of financial statements
practice. particularly the measurement of assets and liabilities.

Technically speaking, however accountancy refers to the A set of high-quality accounting standards is necessity to
profession of accounting practice. ensure comparability and uniformity in financial statements
based on the same financial information.
Accounting is used in reference only to a particular field of
accountancy such as public accounting, private accounting FINANCIAL AND SUSTAINABILITY REPORTING
and government accounting. STANDARDS COUNCIL,

FINANCIAL ACCOUNTING VERSUS MANAGERIAL In the Philippines, the development of generally accepted
ACCOUNTING Philippine accounting principles formalized is initially
through the creation of the Accounting Standards Council
Financial accounting is primarily concerned with the or ASC.
recording of business transactions and the eventual
preparation of financial statements. The Financial Reporting Standards Council or FRSC
replaces the Accounting Standards Council.
Financial accounting focuses on general purpose reports
known as financial statements intended for internal and Based on a resolution issued by the Board of Accountancy,
external users. the ERSC is now renamed Financial and Sustainability
Reporting Standards Council or FSRSC.
Financial accounting is the area of accounting that
emphasizes reporting to creditors and investors. This is due to the adoption of IFRS Sustainability Disclosure
Standards issued by the International Sustainability
Standards Board (ISSB).
The FSRSC is now the accounting standard setting body INTERNATIONAL ACCOUNTING STANDARDS
created by the Professional Regulation Commission-upon COMMITTEE
recommendation of the Board of Accountancy to assist the
Board of Accountancy in carrying out its powers and The International Accounting Standards Committee or
functions provided under R.A. Act No. 9298. IASC is an independent private sector body, with the
objective of achieving uniformity in the accounting
The main function is to establish and improve accounting principles which are used by business and other
standards that will be generally accepted in the Philippines. organizations for financial reporting around the world.

The accounting standards promulgated by the Financial It was formed in June 1973 through an agreement made by
and Sustainability Reporting Standards Council constitute professional accountancy bodics from Australia, Canada,
the highest hierarchy of generally accepted accounting France, Germany, Japan, Mexico, the Netherlands, the
principles in the Philippines. United Kingdom and Ireland, and the United States of
America. The LASC is headquartered in London, United
The approved statements of the FSRSC are known as Kingdom.
Philippine Accounting Standards or PAS and Philippine
Financial Reporting Standards or PFRS. Objectives of IASC

COMPOSITION OF FSRSC a. To formulate and publish in the public interest accounting

standards to be observed in the presentation of financial
The FSRSC is now composed of 16 members with a statements and to promote their worldwide acceptance and
Chairman who had been or is presently a senior accounting observance.
practitioner and 15 representatives from the following:
b. To work generally for the improvement and
1 each harmonization of regulations, accounting standards and
Board of Accountancy procedures relating to the presentation of financial
Securities and Exchange Commission statements.
Bangko Sentral ng Pilipinas
Bureau of Internal Revenue INTERNATIONAL ACCOUNTING STANDARDS BOARD
Commission on Audit
Insurance Commission The International Accounting Standards Board or IASB now
Major organization of preparers and users of financial replaces the International Accounting Standards
statements-Financial Executives Institute of the Committee or IASC.
Philippines or FINEX
The IASB publishes standards in a series of
2each pronouncements called International Financial Reporting
Accredited national professional organization of CPAS: Standards or IFRS.
Public Practice
Commerce and Industry However, the IASB has adopted the body of standards
Academe or Education issued by the IASC.
Government
The pronouncements of the IASC continue to be
The Chairman and members of the FSRSC shall have a designated as International Accounting Standards or IAS.
term of 3 years renewable for another term.
The IASB standard-setting process includes in the correct
PHILIPPINE INTERPRETATIONS COMMITTEE order research, discussion paper, exposure draft and
accounting standard.
The Philippine Interpretations Committee or PIC was
formed by the FSRSC in August 2006 and has replaced the The IASB declared that the merits of proposed standards
Interpretations Committee or IC formed by the Accounting are assessed from a position of neutrality.
Standards Council in May 2000.
A due process system is employed to enable interested
The role of the PIC is to prepare interpretations of PFRS for parties to express their views on issues under
approval by the FSRSC and to provide timely guidance on consideration.
financial reporting issues not specifically addressed in
current PFRS. In other words, interpretations are intended MOVE TOWARD IFRS
to give authoritative guidance on issues that are likely to
receive divergent or unacceptable treatment because the In developing accounting standards that will be generally
standards do not provide specific and clearcut rules and accepted in the Philippines, standards issued by other
guidelines. standard setting bodies such as the USA Financial
Accounting Standards Board (FASB) and the IASB are
The counterpart of the PIC in the International Accounting considered.
Standards Board is the International Financial Reporting
Interpretations Committee or IFRIC. In the past years, most of the Philippine standards are
based on American accounting standards.
At present, the FSRSC has adopted in their entirety all CHAPTER 2 (CONCEPTUAL FRAMEWORK-
International Accounting Standards and International OBJECTIVE OF FINANCIAL REPORTING)
Financial Reporting Standards.
CONCEPTUAL FRAMEWORK
The move toward IFRS is essential to achieve the goal of -is a complete, comprehensive and single document
one uniform and globally accepted financial reporting promulgated by the International Accounting Standards
standards. Board.
-is a summary of the terms and concepts that underlie the
PHILIPPINE FINANCIAL REPORTING STANDARDS preparation and presentation of financial statements for
external users.
The Financial and Sustainability Reporting Standards -describes the concepts for general purpose financial
Council issues standards in a series of pronouncements reporting.
called Philippine Financial Reporting Standards or PFRS. -is an attempt to provide an overall theoretical foundation
for accounting.
The Philippine Financial Reporting Standards collectively -is intended to guide standard setters, preparers and users
include all of the following: of financial information in the preparation and presentation
of statements.
Philippine Financial Reporting Standards which correspond -is the underlying theory for the development of accounting
to International Financial Reporting Standards. standards and revision of previously issued accounting
standards.
The Philippine Financial Reporting Standards are -will be used in future standard setting decision but no
numbered the same as their counterpart in International changes are made to the current IFRS.
Financial Reporting Standards.
The Conceptual Framework provides the foundation for
Philippine Accounting Standards which correspond to Standards that:
International Accounting Standards.
a. Contribute to transparency by enhancing international
The Philippine Accounting Standards are numbered the comparability and quality of financial information.
same as their counterpart in International Accounting b. Strengthen accountability by reducing information gap
Standards. between the providers of capital and the people to whom
they have entrusted their money.
Philippine Interpretations which correspond to c. Contribute to economic efficiency by helping investors to
Interpretations of the IFRIC and Interpretations developed identify opportunities and risks across the world.
by the Philippine Interpretations Committee.
PURPOSES OF REVISED CONCEPTUAL FRAMEWORK

a. To assist the International Accounting Standards Board

to develop IFRS Standards based on consistent concepts.
b. 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.
c. To assist preparers of financial statements to develop
accounting policy when a Standard allows a choice of an
accounting policy.
d. To assist all parties to understand and interpret the IFRS
Standards.

AUTHORITATIVE STATUS OF CONCEPTUAL

FRAMEWORK

If there is a standard or an interpretation that specifically

applies to a transaction, the standard or interpretation
overrides the Conceptual Framework. In the absence of a
standard or an interpretation that specifically applies to a
transaction, management shall consider the applicability of
the Conceptual Framework in developing and applying an
accounting policy that results in information that is relevant
and reliable. However, it is to be stated that the Conceptual
Framework is not an International Financial Reporting
Standard. Nothing in the Conceptual Framework overrides
any specific International Financial Reporting Standard. In
case where there is a conflict, the requirements of the
International Financial Reporting Standards shall prevail
over the Conceptual Framework.
USERS OF FINANCIAL INFORMATION Public- Entities affect members of the public in a variety of
ways. For example, entities make substantial contribution
Under the Conceptual Framework for Financial Reporting, to the local economy in many ways including the number of
the users of financial information may be classified into two, people they employ and their patronage of local suppliers.
namely: Financial statements may assist the public by providing
information about the trend and the range of its activities.
a. Primary users
b. Other users SCOPE OF REVISED CONCEPTUAL FRAMEWORK

PRIMARY USERS 1. Objective of financial reporting

-include the existing and potential investors, lenders and 2. Qualitative characteristics of useful financial information
other creditors. 3. Financial statements and reporting entity
4. Elements of financial statements
OTHER USERS 5. Recognition and derecognition
-include the employees, customers, governments and their 6. Measurement
agencies, and the public. 7. Presentation and disclosure
8 Concepts of capital and capital maintenance
PRIMARY USERS
-The primary users of financial information are the parties OBJECTIVE OF FINANCIAL REPORTING
to whom general purpose financial reports are primarily
directed. Such primary users cannot require reporting The objective of financial reporting forms the foundation of
entities to provide information directly to them and therefore the Conceptual Framework.
must rely on general purpose financial reports for how much
of the financial information is needed. The overall objective of financial reporting is to provide
financial information about the reporting entity that is useful
Existing and potential investors to existing and potential investors, lenders and other
-are concerned with the risk inherent in and return provided creditors in making decisions about providing resources to
by their investments. The investors need information to help the entity. In other words, the objective of financial reporting
them determine whether they should buy, hold or sell. is to provide information about the entity useful to current
Shareholders are also interested in information which and future investors and creditors in making decisions as
enables them to assess the ability of the entity to pay capital providers.
dividends.
The objective of financial reporting is the "why", purpose or
Lenders and other creditors goal of accounting.
-are interested in information which enables them to
determine whether their loans, interest thereon and other Financial reporting is the provision of financial information
amounts owing to them will be paid when due. about an entity to external users that is useful to them in
making economic decisions and for assessing the
OTHER USERS effectiveness of the entity's management
-By residual definition, other users are users of financial
information other than the existing and potential investors, The principal way of providing financial information to
lenders and other creditors. Other users are so called external users is through the annual financial statements.
because they are parties that may find the general purpose
financial reports useful but the reports are not directed to However, financial reporting encompasses not only
them primarily. financial statements but also other information such as
financial highlights, summary of important financial figures,
Employees analysis of financial statements and significant ratios.
-are interested in information about the stability and
profitability of the entity. The employees are interested in Financial reports also include nonfinancial information such
information which enables them to assess the ability of the as description of major products and a listing of corporate
entity to provide remuneration, retirement benefits and officers and directors.
employment opportunities.
TARGET USERS
Customers
-have an interest in information about the continuance of an Financial reporting is directed primarily to the existing and
entity especially when they have a long-term involvement potential investors, lenders and other creditors which
with or are dependent on the entity. 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
Governments and their agencies
in financial reports.
-are interested in the allocation of resources and therefore
the activities of the entity. These users require information
As a matter of fact, the primary users of financial
to regulate the activities of the entity, determine taxation
information are the parties that provide resources or capital
policies and as a basis for national income and similar
to the entity.
statistics.
Moreover, information that meets the needs of the specified In other words, the financial position comprises the assets.
primary users is likely to meet the needs of other users such liabilities and equity of an entity at a particular moment in
as employees, customers, governments and their time.
agencies.
Information about the nature and amounts of an entity's
The management of a reporting entity is also interested in economic resources and claims can help users identify the
financial information about the entity. However, entity's financial strength and weakness. Otherwise stated,
management need not rely on general purpose financial information about financial position can help users to
reports because it is able to obtain or access additional assess the entity's liquidity, solvency and the need for
financial information internally. additional financing.

SPECIFIC OBJECTIVES OF FINANCIAL REPORTING Liquidity is the availability of cash in the near future to cover
currently maturing obligations.
The overall objective of financial reporting is to provide
information useful for decision making. The Conceptual Solvency is the availability of cash over a long term to meet
Framework places more emphasis on the importance of financial commitments when they fall due.
providing information needed to assess the management
stewardship of the entity's economic resources. Information about priorities and payment requirements of
existing claims can help users to predict how future cash
Specifically, the objectives of financial reporting are: flows will be distributed among those with a claim against
the reporting entity.
a. To provide information useful in making decisions about
providing resources to the entity. CHANGES IN ECONOMIC RESOURCES AND CLAIMS
b. To provide information useful in assessing the cash flow
prospects of the entity. General purpose financial reports also provide information
c. To provide information about entity resources, claims and about the effects of transactions and other events that
changes in resources and claims. change the economic resources and claims.

ECONOMIC DECISIONS Changes in economic resources and claims result from

financial performance and from other events or
Existing and potential investors need general purpose transactions, such as issuing debt or equity instruments.
financial reports in order to enable them in making
decisions whether to buy, sell or hold equity investments. The financial performance of an entity comprises revenue,
expenses and net income or loss for a period of time.
Existing and potential lenders and other creditors need
general purpose financial reports in order to enable them in In other words, financial performance is the level of income
making decisions whether to provide or settle loans and earned by the entity through the efficient and effective use
other forms of credit. of its resources.

ASSESSING CASH FLOW PROSPECTS The financial performance of an entity is also known as
results of operations and is portrayed in the income
Decisions by existing and potential investors about buying, statement and statement of comprehensive income.
selling or holding equity instruments depend on the returns
that they expect from an investment, for example, USEFULNESS OF FINANCIAL PERFORMANCE
dividends.
Information about financial performance helps users to
Similarly, decisions by existing and potential lenders and understand the return that the entity has produced on the
other creditors about providing or settling loans and other economic resources.
forms of credit depend on the principal and interest
payments or other returns that they expect. Information about the return the entity has produced
provides an indication of how well management has
Consequently, financial reporting should provide discharged its responsibilities to make efficient and
information useful in assessing the amount, timing and effective use of the entity's economic resources.
uncertainty of an entity's cash flows and the ability of the
entity to generate future net cash flows. Information about past financial performance is usually
helpful in predicting the future returns on the entity's
ECONOMIC RESOURCES AND CLAIMS economic resources.

General purpose financial reports provide information about Information about financial performance during a period is
the financial position of a reporting entity. Financial position useful is assessing the entity's ability to generate future
is information about the entity's economic resources and cash inflows from operations.
the claims against the reporting entity. The economic
resources are the assets and the claims are the liabilities
and equity of the entity.
ACCRUAL ACCOUNTING CHAPTER 3 (CONCEPTUAL FRAMEWORK-
QUALITATIVE CHARACTERISTICS)
The financial performance of the entity must be measured
using the accrual basis of accounting. QUALITATIVE CHARACTERISTICS
-are the qualities or attributes that make financial
Accrual accounting depicts the effects of transactions and accounting information useful to the users. In deciding
other events and circumstances on an entity's economic which information to include in financial statements, the
resources and claims in the periods in which those effects objective is to ensure that the information is useful to the
occur even if the resulting cash receipts and payments users in making economic decisions.
occur in a different period.
Under the Conceptual Framework for Financial Reporting.
In other words, under the accrual basis, the effects of qualitative characteristics are classified into fundamental
transactions and other events are recognized when they qualitative characteristics and enhancing qualitative
occur and not as cash is received or paid. characteristics.

Simply stated, accrual accounting means that income is FUNDAMENTAL QUALITATIVE CHARACTERISTICS
recognized when earned regardless of when received and -relate to the content or substance of financial information.
expense is recognized when incurred regardless of when
paid. The fundamental qualitative characteristics are releuance
and faithful representation. For information to be useful
Information about financial performance measured in for decision making, it must be both relevant and a faithful
accordance with accrual accounting provides a better basis representation of the economic transactions that it
for assessing past and future performance than information represents. Neither a faithful representation of an irrelevant
solely about cash receipts and payments during a period phenomenon nor an unfaithful representation of a relevant
phenomenon helps users make good decisions.
LIMITATIONS OF FINANCIAL REPORTING
APPLICATION OF QUALITATIVE CHARACTERISTICS
a. General purpose financial reports do not and cannot
provide all of the information that existing and potential The most efficient and effective process of applying the
investors, lenders and other creditors need. Primary users fundamental qualitative characteristics would usually be:
need to consider pertinent information from other sources,
for example, general economic conditions, political events First, identify an economic phenomenon or transaction that
and industry outlook. has the potential to be useful.

b. General purpose financial reports are not designed to Second, identify the type of information about the
show the value of an entity but the reports provide phenomenon or transaction that would be most relevant
information to help the primary users estimate the value of and can be faithfully represented,
the entity.
Third, determine whether the information is available.
C. General purpose financial reports are intended to
provide common information to users and cannot RELEVANCE
accommodate every request for information.
In the simplest terms, relevance is the capacity of the
d. To a large extent, general purpose financial reports are information to influence a decision. To be relevant, the
based on estimate and judgment rather than exact financial information must be capable of making a
depiction. difference in the decisions made by users. In other words,
relevance requires that the financial information should be
MANAGEMENT STEWARDSHIP related or pertinent to the economy decision. Information
that does not bear on an economic decision is useless. To
Management stewardship is the responsibility of be useful, information must be relevant to the decision
management in efficiently and effectively using the making needs of users.
economic resources of the entity.
For example, broadly, the statement of financial position
Such information on management stewardship is useful for relevant in determining financial position, and the income
predicting how management will use the entity's economic statement is relevant in determining performance.
resources in future periods.
More specifically, the earnings per share information is
Moreover, the information on management stewardship more relevant than book value per share in determining the
can be useful for assessing the entity's prospects for future attractiveness of an investment.
net cash flows.
INGREDIENTS OF RELEVANCE Materiality is a relativity

Financial information is capable of making a difference in a Materiality of an item depends on relative size rather than
decision if it has predictive value and confirmatory value. absolute size. What is material for one entity may be
immaterial for another.
Financial information has predictive value if it can be used
as an input by users to predict future outcome. In other An error of P500,000 in the financial statements of an
words, financial information has predictive value when it multinational entity may not be important but may be critical
can help users increase the likelihood of correctly or for a small entity.
accurately predicting or forecasting outcome of events.
When is an item material?
For example, information about financial position and past
performance is frequently used in predicting dividend and There is no strict or uniform rule for determining whether an
wage payments and the ability of the entity to meet item is material or not.
maturing commitments.
Very often, this is dependent on good judgment,
The net cash provided by operating activities is valuable in professional expertise and common sense.
predicting loan payment or default.
As a general guide, an item is material if knowledge of it
Financial information has confirmatory value if it provides could reasonably affect or influence the economic decision
feedback about previous evaluations. In other words, of the primary users of the financial statements.
financial information has confirmatory value when it
enables users confirm or correct earlier expectations New definition of materiality

For example, a net income measure has confirmatory value The IASB provided the following new definition of
if it can help shareholders confirm or revise their materiality.
expectation about an entity's ability to generate earnings.
Information is material if omitting, misstating or obscuring
Often, information has both predictive and confirmatory could reasonably be expected to influence the economic
value The predictive and confirmatory roles of information decisions that primary users of general purpose financial
are interrelated statements make on the basis of those statements which
provide financial information about a specific reporting
An example is an interim income statement which provides entity.
feedback about income to date and serves as a basis for
predicting the annual income. The revised definition of materiality highlights three
important aspects:
The interim income statement for the first quarter shows net
income of P2,000,000. This information is the confirmatory a. Could reasonably be expected to influence
value. b. Obscuring information
c. Primary users
If this trend continues for the entire year, it is logical to
assume that the net income after four quarters or one year Could reasonably be expected to influence
would be P8,000,000. This information is the predictive -adds an element of reasonability of financial information on
value. which economic decision is based. By including the term
could reasonably be expected to influence in the new
MATERIALITY definition, material information shall be limited to the
economic decision of primary users rather than to all users
Materiality is a practical rule in accounting which dictates which is too broad in scope. Moreover, the could
that strict adherence to GAAP is not required when the reasonably be expected to influence threshold insures that
items are not significant enough to affect the evaluation, information capable of influencing economic decision of the
decision and fairness of the financial statements. primary users shall be included in the financial statements.

The materiality concept is also known as the doctrine of Obscuring information

convenience. Materiality is really a quantitative threshold -is a new concept added to the new definition of materiality.
linked very closely to the qualitative characteristic of Information is obscured if presenting or communicating it
relevance. The relevance of information is affected by its would have a similar effect as omitting or misstating the
nature and materiality. information. Obscuring information means the presentation
of financial information not readily understood or not clearly
In other words, materiality is a subquality or attribute of expressed. Obscuring information may be characterized by
relevance based on the nature or magnitude or both of the deliberate vagueness, ambiguity and abstruseness.
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.
Examples of obscured material information are: FAITHFUL REPRESENTATION

a. The language is vague or unclear. Faithful representation means that financial reports
b. The information is scattered throughout the financial represent economic phenomena or transactions in words
statements. and numbers. Stated differently, the reported descriptions
c. Dissimilar items are aggregated inappropriately. and figures must match what really existed or happened.
d. Similar items are disaggregated inappropirately
Simply worded, faithful representation means that the
Primary users actual effects of the transactions shall be properly
-The new definition of materiality narrows the definition to accounted for and reported in the financial statements.
primary users who are primarily affected by general
purpose financial statements. The primary users include For example, if an entity reports land at P3,000,000, the
the existing and potential investors, lenders and other entity must actually have purchased the land that much. If
creditors. the entity reports purchases of P5,000,000 when the actual
amount is P8,000,000, the information would not be
The new definition specified that only primary users of faithfully represented. To record a sale of merchandise as
financial statements are considered because these groups miscellaneous income would not also be a faithful
are the users to whom general purpose financial statements representation of the sale transaction.
are primarily directed.
Faithful representation replaces reliability as a primary
Such primary users cannot require reporting entities to quality.
provide information directly to them and therefore must rely
on general purpose financial reports for how much financial Ingredients of faithful representation
information is needed. To be a perfectly faithful representation, a depiction should
have three characteristics, namely:
The other users include the employees, customers,
government agencies and the public in general. a. Completeness
b. Neutrality
Factors of materiality c. Free from error

Materiality depends on the magnitude and nature of the COMPLETENESS

financial information. -requires that relevant information should be presented in a
way that facilitates understanding and avoids erroneous
In the exercise of judgment in determining materiality, the implication. A complete depiction includes all information
relative size and nature of an item are considered. necessary for a user to understand the phenomenon or
transaction being depicted, including all necessary
The size of the item in relation to the total of the group to description and explanation.
which the item belongs is taken into account.
Actually, to be complete, the financial statements shall be
For example, the amount of advertising in relation to total accompanied by notes to financial statements. The purpose
selling expenses, the amount of office salaries to total of the notes is to provide the necessary disclosures
administrative expenses, the amount of prepaid expenses required by Philippine Financial Reporting Standards.
to total current assets and the amount of leasehold
improvements to total property, plant and equipment. Standard of adequate disclosure

The nature of the item may be inherently material because Completeness is the result of the standard of disclosure
by its very nature it affects economic decision. principle or of full disclosure adequate

For example, the discovery of a P20, 000 bribe is a material The standard of adequate disclosure means that all
event even for a very large entity. significant and relevant information leading to the
preparation of financial statements shall be clearly
reported.

Adequate disclosure however does not mean disclosure of

just any data.

The accountant shall disclose a material fact known to him

which is not disclosed in the financial statements but
disclosure of which is necessary in order that the financial
statements would not be misleading.

The standard of adequate disclosure is best described by

disclosure of any financial facts significant enough to
influence the judgment of informed users.
NEUTRALITY FREE FROM ERROR
-is without bias in the preparation or presentation of -means there are no errors or omissions in the description of
financial information. the phenomenon or transaction.
-is not slanted, weighted, emphasized, de-emphasized or
otherwise manipulated to increase the probability that Moreover, the process used to produce the reported
financial information will be received favorably or information has been selected and applied with no errors in
unfavorably by users. the process.

In other words, to be neutral, the information contained in Measurement uncertainty

the financial statements must be free from bias. The -arises when monetary amounts in financial reports cannot be
financial information should not favor one party to the observed directly and must instead be estimated. It can affect
detriment of another party. The information is directed to faithful representation if the level of uncertainty in providing
the common needs of many users and not to the particular an estimate is high. However, the use of reasonable estimate
needs of specific users. is an essential part of providing financial information and does
not undermine the usefulness of the financial information. As
Neutrality is synonymous with the all-encompassing long as the estimate is clearly and accurately described and
principle of fairness. To be neutral is to be fair. explained, even a high level of measurement uncertainty
does not affect the usefulness of the financial information.
For example, an entity may be reluctant to report a net loss.
Neutrality requires that a net loss should be reported Substance over form
regardless of any possible effect on the entity. If information is to represent faithfully the transactions and
other events it purports to represent, it is necessary that the
Prudence transactions and events are accounted for in accordance with
The Revised Conceptual Framework has reintroduced the their substance and not merely their legal form.
concept of prudence.
The economic substance of transactions and events are
Prudence is the exercise of care and caution when dealing usually emphasized when economic substance differs from
with the uncertainties in the measurement process such legal form. Substance over form is not considered a separate
that assels or income are not overstated and liabilities or component of faithful representation because it would be
expenses are not understated. redundant. Faithful representation inherently represents the
substance of an economic phenomenon or transaction rather
Neutrality is supported by the exercise of prudence. than merely representing the legal form.

Conservatism Example of substance over form

-is synonymous with prudence. An example is when the lessee leased property from the
-means that when alternatives exist, the alternative which lessor. The terms of the lease provide that the lease transfers
has the least effect on equity should be chosen. ownership of the asset to the lessee by the end of the lease
-In the simplest words, conservatism means "in case of term.
doubt, record any loss and do not record any gain."
In form, the contract is a lease as popularly understood. But
For example, if there is a choice between two acceptable in substance, in reality, if the "transfer of ownership provision"
asset values, the lower figure is selected. Accordingly, is to be considered, the real intent of the parties is an
inventories are measured at the lower of cost and net installment purchase of an asset by the lessee from the
realizable value. lessor. Accordingly, the lessee shall record an acquisition of
right of use asset and set up a liability to the lessor. The
Contingent loss is recognized in the financial statements if periodic rental is conceived as an installment payment
the loss is probable and the amount can be reliably representing interest and principal.
measured. However, contingent gain is not recognized but
disclosed only. Relevance over faithful representation
Relevance and faithful representation may conflict in which
It is to be emphasized that conservatism is not a license to case a tradeoff is made favoring one or the other. The
deliberately understate net income and net assets. pervasive use of accounting estimate, for example
depreciation, doubtful accounts, contingencies, is an example
For example, if an entity has a cash of P500,000 and of emphasizing relevance over faithful representation.
reports only P100,000, this is not conservatism but fraud or Entities are providing estimates rather than certain amounts.
inaccurate reporting.
Reasonable approximations, although not perfectly reliable
Expressions of conservatism are preferred by financial statement users over either perfect
“Anticipate no profit and provide for probable and information issued too late to make a decision or no
measurable loss. In the matter of income recognition, the information at all.
accountant takes the position that no matter how sure the
businessman might be in capturing the bird in the bush, he,
the accountant, must see it in the hand."

"Don't count your chicks until the eggs hatch".

Faithful representation over relevance Comparability is the goal and consistency helps to achieve
In the opinion of many, the use of historical cost as a that goal.
valuation base is an example of emphasizing faithful
representation over relevance. In a limited sense, consistency is the uniform application of
accounting method from period to period within an entity.
Historical cost is very reliable because it is based on
objectively verifiable past information. However, historical On the other hand, comparability is the uniform application
cost is considered to be less current and therefore less of accounting method between and across entities in the
relevant than market value. same industry.

ENHANCING QUALITATIVE CHARACTERISTICS An entity cannot use the FIFO method of inventory
-relate to the presentation or form of the financial valuation in one year, the average method in the next year,
information. again the FIFO method in succeeding year and so on.
-are intended to increase the usefulness of the financial
information that is relevant and faithfully represented. If the FIFO method is adopted in one year, such method is
 COMPARABILITY,UNDERSTANDABILITY, followed from year to year. Consistency is desirable and
VERIFIABILITY AND TIMELINESS. essential to achieve comparability of financial statements.

Relevant and faithfully represented financial information is However, consistency does not mean that no change in
useful but the information would be most useful if it is accounting method can be made. If the change would result
comparable, understandable, verifiable and timely. to more useful and meaningful information, then such
change shall be made. But there shall be full disclosure of
COMPARABILITY the change and the peso effect thereof.

Comparability means the ability to bring together for the It is inappropriate for an entity to leave accounting policies
purpose of noting points of likeness and difference. unchanged when better and acceptable alternatives exist.

Comparability is the enhancing qualitative characteristic UNDERSTANDABILITY

that enables users to identify and understand similarities
and dissimilarities among items. Understandability requires that financial information must
be comprehensible or intelligible if it is to be most useful.
Comparability may be made within an entity or between and
across entities. Accordingly, the information should be presented in a form
and expressed in terminology that a user understands.
Comparability within an entity is the quality of information
that allows comparisons within a single entity through time Classifying, characterizing and presenting information
or from one accounting period to the next. "clearly and concisely" makes it understandable.

Comparability within an entity is also known as horizontal An essential quality of the information provided in financial
comparability or intracomparability. statements is that it is readily understandable by users.

Comparability between and across entities is the quality of But the complex economic activities make it impossible to
information that allows comparisons between two or more reduce the financial information to the simplest terms.
entities engaged in the same industry.
Accordingly, the users shall have an understanding of the
Comparability across entities is also known as complex economic activities, the financial accounting
intercomparability or dimensional comparability. process and the terminology in the financial statements.

For information to be comparable, like things must look Financial statements cannot realistically be understandable
alike and different things must look different. to everyone. Financial reports are prepared for users who
have a reasonable knowledge of business and economic
Comparability is not enhanced by making unlike things look activities and who review and analyze the information
alike or making like things look different. diligently.

Consistency In other words, users are assumed to have a reasonable

understanding of business and accounting and are willing
Implicit in the qualitative characteristic of comparability is to study the information with reasonable diligence,
the principle of consistency.
At times, even well-informed and diligent users may need
Consistency is not the same as comparability. to seek the aid of an adviser to understand information
about complex phenomena or transactions.
In a broad sense, consistency refers to the use of the same
method for the same item, either from period to period Understandability is very essential because a relevant and
within an entity or in a single period across entities. faithfully represented information may prove useless if it is
not understood by users.
VERIFIABILITY TIMELINESS

Verifiability means that different knowledgeable and Timeliness means that financial information must be
independent observers could reach consensus, although available or communicated early enough when a decision
not necessarily complete agreement, that a particular is to be made
depiction is a faithful representation.
Information is timely if it is received on time to make a
In other words, information is verifiable if different and difference to the decision maker.
knowledgeable and independent observers could reach
similar conclusions based on the information. Relevant and faithfully represented financial information
furnished after a decision is made is useless or of no value."
Verifiability implies consensus.
For example, the most important attribute of quarterly or
The financial information is verifiable in the sense that it is interim financial information is its timeliness.
supported by evidence so that an accountant that would
look into the same evidence would arrive at the same Generally, the older the information, the less useful.
economic decision or conclusion.
However, some information may continue to be timely long
Verifiable financial information provides results that would after the end of reporting period because some users may
be substantially duplicated by measurers using the same need to identify and assess trends.
measurement method.
Timeliness enhances the truism that without knowledge of
Accordingly, verifiability helps assure users that information the past, the basis for prediction will usually be lacking and
represents the economic phenomenon or transaction it without interest in the future, knowledge of the past is sterile
purports to represent.
What happened in the past would become the basis of what
Verifiability is synonymous with objectivity. would happen in the future.

Types of verification Cost constraint on useful information

Verification can be direct or indirect.
Cost is a pervasive constraint on the information that can
Direct verification means verifying an amount or other be provided by financial reporting.
representation through direct observation, for example, by
counting cash. Reporting financial information imposes cost and it is
important that such cost is justified by the benefit derived
Indirect verification means checking the inputs to a model, from the financial information.
formula or other technique and recalculating the inputs
using the same methodology. In other words, the cost constraint is a consideration of the
cost incurred in generating financial information against the
An example is verifying the carrying amount of inventory by benefit to be obtained from having the information.
checking the inputs in quantities and costs, and
recalculating the ending inventory using the same cost flow The benefit derived from the information should exceed the
assumption. such as first-in, first-out. cost incurred in obtaining the information.

However, the evaluation of the cost constraint is

substantially a judgmental process.

Assessing whether the cost of reporting outweighs or falls

short of the benefit is difficult to measure and becomes
matter of professional judgment.
CHAPTER 4 (CONCEPTUAL FRAMEWORK- UNCONSOLIDATED FINANCIAL STATEMENTS
FINANCIAL STATEMENTS AND REPORTING
ENTITY UNDERLYING ASSUMPTION) Unconsolidated financial statements are designed to
provide information about the parent's assets, liabilities,
income and expenses and not about those of the
GENERAL OBJECTIVE OF FINANCIAL STATEMENTS
subsidiaries.
Financial statements provide information about economic
Such information can be useful to the existing and potential
resources of the reporting entity, claims against the entity
investors, lenders and other creditors of the parent because
and changes in the economic resources and claims. It also
a claim against the parent typically does not give the holder
provide financial information about an entity's assets,
of that claim against subsidiaries.
liabilities, equity, income and expenses useful to users of
financial statements in:
Information provided in unconsolidated financial statements
is typically not sufficient to meet the requirement needs of
a. Assessing future cash flows to the reporting entity.
primary users.
b. Assessing management stewardship of the entity's
economic resources.
Accordingly, when consolidated financial statements are
required, unconsolidated financial statements cannot serve
The financial information is provided in the following:
as substitute for consolidated financial statements.
1. Statement of financial position, by recognizing assets,
liabilities and equity
COMBINED FINANCIAL STATEMENTS
2. Income statement, by recognizing income and expenses
3. Statement of cash flows, by recognizing cash flows from
Combined financial statements provide financial
operating, investing and financing activities
information about the assets, liabilities, equity, income and
4. Statement of changes in equity, by recognizing
expenses of two or more entities not linked with parent and
contributions from equity holders and distributions to equity
subsidiary relationship.
holders
5. Notes to financial statements, by recognizing disclosures
required by accounting standards REPORTING ENTITY

A reporting entity is an entity that is required or chooses to

TYPES OF FINANCIAL STATEMENTS
prepare financial statements.
The Revised Conceptual Framework recognizes three
The reporting entity can be a single entity or a portion of an
types of financial statements.
entity, or can comprise more than one entity.
1. Consolidated financial statements are the financial
statements prepared when the reporting entity comprises
A reporting entity is not necessarily a legal entity.
both the parent and its subsidiaries.
2. Unconsolidated financial statements are the financial
Accordingly, the following can be considered a reporting
statements prepared when the reporting entity is the parent
entity:
alone.
3. Combined financial statements are the financial
statements when the reporting entity comprises two or more a. Individual corporation, partnership or proprietorship
entities that are not linked by a parent and subsidiary b. The parent alone
relationship. c. The parent and its subsidiaries as single reporting entity
d. Two or more entities without parent and subsidiary
CONSOLIDATED FINANCIAL STATEMENTS relationship as a single reporting entity
e. A reportable business segment of an entity
Consolidated financial statements provide information
REPORTING PERIOD
about the assets, liabilities, equity, income and expenses of
both the parent and its subsidiaries as a single reporting
The reporting period is the period when financial statements
entity. The parent is the entity that exercises control over
the subsidiaries. are prepared for general purpose financial reporting.

Consolidated information is useful for existing and potential Financial statements may be prepared on an interim basis,
for example, three months, six months or nine months.
investors, lenders and other creditors of the parent in their
assessment of future net cash inflows to the parent.
Interim financial statements are not required but optional.
This is because net cash inflows to the parent include
However, financial statements must be prepared on an
distributions to the parent from its subsidiaries.
annual basis or a period of twelve months.
Consolidated financial statements are not designed to
provide separate information about the assets, liabilities Financial statements are prepared for a specified period of
time and provide information about:
equity, income and expenses of a particular subsidiary.
 Assets, liabilities and equity at the end of the
A subsidiary's own financial statements are designed to reporting period.
provide such information  Income and expense during the reporting period.

b. Income and expenses during the reporting period.

To help users of financial statements to identify and assess ACCOUNTING ENTITY
change in trends, financial statements also provide
comparative information for at least one preceeding In financial accounting, the accounting entity is the specific
reporting period. business organization, which may be a proprietorship,
partnership or corporation.
Financial statements may include information about
transactions and other events that occurred after the end of Under this assumption, the entity is separate from the
reporting period if the information is necessary to meet the owners, managers, and employees who constitute the
general objective of financial statements. entity.

UNDERLYING ASSUMPTIONS Accordingly, the transactions of the entity shall not be

merged with the transactions of the owners.
Accounting assumptions or accounting postulates are the
basic notions or fundamental premises on which the The reason for the entity assumption is to have a fair
accounting process is based. presentation of financial statements.

Like a building structure that requires a solid foundation to The personal transactions of the owners shall not be
avoid or prevent future collapse and provide room for allowed to distort the financial statements of the entity.
expansion, and so with accounting.
For example, the cash invested by the proprietor is treated
Accounting assumptions serve as the foundation or as an asset of the proprietorship.
bedrock of accounting in order to avoid misunderstanding
but rather enhance the understanding and usefulness of the If an enterprising entrepreneur owns department store,
financial statements. restaurant and bookstore, separate statements shall be
prepared for each business in order to determine which
The Conceptual Framework for Financial Reporting business is profitable.
mentions only one assumption, namely going concern.
However, implicit in accounting are the basic assumptions Each business is an independent accounting entity.
of accounting entity, time period and monetary unit.
When a major shareholder of a corporation borrows money
GOING CONCERN from a bank on his own personal account, the loan is a
liability of the shareholder alone and not of the corporation.
The going concern or continuity assumption means that in
the absence of evidence to the contrary, the accounting The shareholder is not the corporation and the corporation
entity is viewed as continuing in operation indefinitely. is not the shareholder.

In other words, the financial statements are normally The shareholders and the corporation are separate. The
prepared on the assumption that the entity will continue in shareholders own the shares but they do not own the
operations for the foreseeable future. assets of the corporation. The corporation owns the assets.

The going concern postulate is the very foundation of the However, where parent and subsidiary relationship exists.
cost principle. consolidated statements for the affiliates are usually made
because for practical and economic purposes, the parent
Thus, assets are normally recorded at cost. As a rule, and the subsidiary are a single economic entity.
market values are ignored.
The consolidation, however, does not eliminate the legal
However, some new standards require measurement of boundary segregating the affiliated entities.
certain assets at fair value.
Accounting will continue to be done separately for each
If there is evidence that the entity would experience large entity.
and persistent losses or that the entity's operations are to
be terminated, the going concern assumption is
abandoned.

In this case, the users of the statements will have a great

interest in the amount of cash that will be generated from
the entity's assets in the short term.
TIME PERIOD MONETARY UNIT

A completely accurate report on the financial position and The monetary unit assumption has two aspects, namely
performance of an entity cannot be obtained until the entity quantifiability and stability of the peso.
is finally dissolved and liquidated.
The quantifiability aspect means that the assets, liabilities,
Only then can the final net income and networth of the entity equity, income and expenses should be stated in terms of
be determined precisely. a unit of measure which is the peso in the Philippines.

However, users of financial information need timely How awkward to see financial statements without any
information for making an economic decision. common unit of measure. Such statements would be largely
unintelligible and incomprehensible.
For accounting information to be relevant, it must be timely.
The stability of the peso assumption means that the
The reliability of the information often must be sacrificed to purchasing power of the peso is stable or constant and that
provide relevant disclosure. its instability is insignificant and therefore may be ignored.

The use of estimate is required for timely reporting but also The stable peso postulate is actually an amplification of the
implies a possible loss of reliability. going concern assumption so much so that adjustments are
unnecessary to reflect any changes in purchasing power.
It becomes necessary therefore to prepare periodic reports
on financial position, performance and cash flows of an The accounting function is to account for nominal pesos
entity. only and not for constant pesos or changes in purchasing
power.
The time period assumption requires that the indefinite life
of an entity is subdivided into accounting periods which are In today's world, the assumption that the peso is a stable
usually of equal length for the purpose of preparing financial measure over time is not necessarily valid.
reports on financial position, performance and cash flows.
Consider an equipment that was imported 10 years ago
By convention, the accounting period or fiscal period is one from the United States for $100,000 when the exchange
year or a period of twelve months. rate was P40 to $1 or an equivalent of P4,000,000.

The one-year period is traditionally the accounting period If the same equipment is purchased now and assuming
because usually it is after one year that government reports there is no change in the $100,000 purchase price, the
are required. replacement cost in terms of pesos would be in the vicinity
of P5,500,000, considering a current exchange rate of P55
The accounting period may be a calendar year or a natural to $1.
business year.
Obviously, there is a significant gap between historical cost
A calendar year is a twelve-month period that ends on and current replacement cost.
December 31.
In this regard, an entity may choose the revaluation model
A natural business year is a twelve-month period that ends as an accounting policy.
on any month when the business is at the lowest or
experiencing slack season.
CHAPTER 5 (CONCEPTUAL FRAMEWORK- ESSENTIAL CHARACTERISTICS OF ASSET
ELEMENTS OF FINANCIAL STATEMENTS)
a. The asset is a present economic resource.
Financial statements portray the financial effects of b. The economic resource is a right that has the potential to
transactions and other events by grouping them into broad produce economic benefits.
classes according to their economic characteristics. c. The economic resource is controlled by the entity as a
result of past events.
These broad classes are termed the elements of financial
statements. RIGHT

The elements of financial statements refer to the Rights that have the potential to produce economic benefits
quantitative information reported in the statement of may take the following forms:
financial position and income statement.
1. Rights that correspond to an obligation of another entity
The elements of financial statements are the building blocks a. Right to receive cash
from which financial statements are constructed. b. Right to receive goods or services
c. Right to exchange economic resources with another
The presentation of these elements in the statement of party on favorable terms
financial position and the income statement involves a d. Right to benefit from an obligation of another party if a
process of classification and subclassification. specified uncertain future event occurs

For example, assets and liabilities may be classified by their 2. Rights that do not correspond to an obligation of another
nature or function in the business of the entity in order to entity
display information in a manner most useful to users for a. Right over physical objects, such as property, plant and
purposes of making economic decisions. equipment or inventories
b. Right to intellectual property
The elements directly related to the measurement of
financial position are: 3. Rights established by contract or legislation such as
owning a debt instrument or an equity instrument or owning
a. Asset a registered patent.
b. Liability
c. Equity POTENTIAL TO PRODUCE ECONOMIC BENEFITS

The elements directly related to the measurement of An economic resource is a right that has the potential to
financial performance are: produce economic benefits.

a. Income For the potential to exist, it does not need to be certain or

b. Expense even likely that the right will produce economic benefits.

The Conceptual Framework identifies no elements that are It is only necessary that the right already exists.
unique to the statement of changes in equity because such
statement comprises items that appear in the statement of A right can meet the definition of an economic resource
financial position and the income statement. even if the probability that it will produce economic benefit
is low.
Equity is the residual interest in the assets of the entity after
deducting all of the liabilities. The economic resource is the present right that contains
the potential and not the future economic benefits that the
ASSET right may produce.

Under the Revised Conceptual Framework, an asset is An economic resource could produce economic benefits if
defined as a present economic resource controlled by the an entity is entitled:
entity as a result of past events.
a. To receive contractual cash flows
An economic resource is a right that has the potential to b. To exchange economic resources with another party on
produce economic benefits. favorable terms
c. To produce cash inflows or avoid cash outflows
The new definition clarifies that an asset is an economic d. To receive cash by selling the economic resource
resource and that the potential economic benefits no longer e. To extinguish a liability by transferring an economic
need to be expected to flow to the entity. resource
CONTROL OF AN ECONOMIC RESOURCE TRANSFER OF AN ECONOMIC RESOURCE
Obligations to transfer an economic resource include:
An entity controls an asset if it has the present ability to
direct the use of the asset and obtain the economic benefits a. Obligation to pay cash
that flow from it. b. Obligation to deliver goods or noncash resources
c. Obligation to provide services at some future time
Control also includes the ability to prevent others from using d. Obligation to exchange economic resources with another
such asset and therefore preventing others from obtaining party on unfavorable terms
the economic benefits from the asset. e. Obligation to transfer an economic resource if specified
uncertain future event occurs
Control may arise if an entity enforces legal rights. If there
are no legal rights, control can still exist if an entity has other PAST EVENT
means of ensuring that no other party can benefit from an An obligation exists as a result of past event if both of the
asset. For example, an entity has access to technical know- following conditions are satisfied:
how and has the ability to keep this know-how secret.
a. An entity has already obtained economic benefits.
LIABILITY b. An entity must transfer an economic resource.

Under the Revised Conceptual Framework, a liability is DEFINITION OF INCOME

defined as present obligation of an entity to transfer an
economic resource as a result of past events. Income is defined as increases in assets or decreases in
liabilities that result in increases in equity, other than those
The new definition clarifies that a liability is the obligation to relating to contributions from equity holders.
transfer an economic resource and not the ultimate outflow
of economic benefits. The definition of income has changed to reflect the change
in the definition of asset and liability.
The outflow of economic benefits no longer needs to be
expected similar to the definition of an asset. The new Income encompasses both revenue and gains.
definition of liability to some extent is inconsistent with the
definition of liability under IAS 37. In case of conflict, the Revenue arises in the course of the ordinary regular
IASB stated that the requirements of a Standard shall activities and is referred to by variety of different names
always prevail over the Conceptual Framework. including sales, fees, interest, dividends, royalties and rent.

ESSENTIAL CHARACTERISTICS OF LIABILITY The essence of revenue is regularity.

a. The entity has an obligation. Gains represent other items that meet the definition of
The entity liable must be identified. However, it is not income and do not arise in the course of the ordinary
necessary that the payee or the entity to whom the regular activities. Gains include gain from disposal of
obligation is owed be identified. noncurrent asset, unrealized gain on trading investment
b. The obligation is to transfer an economic resource. and gain from expropriation.
c. The obligation is a present obligation that exists as a
result of past event. STATEMENT OF FINANCIAL PERFORMANCE
The Revised Conceptual Framework introduces the term
This means that a liability is not recognized until it is statement of financial performance.
incurred.
The statement of financial performance refers to the income
OBLIGATION statement and a statement presenting other
comprehensive income.
An obligation is a duty or responsibility that an entity has no
practical ability to avoid. Obligations can either be legal or The income statement is the primary source of information
constructive about an entity's financial performance. As a general rule,
all income and expenses are included in profit or loss.
Obligations may be legally enforceable as a consequence However, in developing accounting standards, there are
of a binding contract or statutory requirement. some items of income and expenses that are included in
other comprehensive income and not in profit or loss if such
This is normally the case, for example, with accounts presentation would provide more relevant and faithfully
payable for goods and services received. represented information about financial performance.

Constructive obligations arise from normal business There are instances that an amount in other comprehensive
practice, custom and a desire to maintain good business income in one reporting period may be recycled to profit or
relations or act in an equitable manner. loss in another reporting period.

For example, an entity decides as a matter of policy to Such recycling is permitted as long as it would result to
rectify faults in the products even when these become relevant and faithfully represented information about
apparent after the warranty period financial performance.
DEFINITION OF EXPENSE CHAPTER 6 (CONCEPTUAL FRAMEWORK-
RECOGNITION AND MEASUREMENT)
Expense is defined as decreases in assets or increases in
liabilities that result in decreases in equity, other than those RECOGNITION
relating to distributions to equity holders.
The Revised Conceptual Framework defines recognition as
The definition of expense has changed to reflect the change the process of capturing for inclusion in the financial
in the definition of asset and liability. statements an item that meets the definition of an asset,
liability, equity, income or expense. The amount at which an
Expenses encompass losses as well as those expenses asset, a liability or equity is recognized in the statement of
that arise in the course of the ordinary regular activities. financial position is reported as carrying amount.

Expenses that arise in the course of ordinary regular Recognition links the elements to the statement of financial
activities include cost of goods sold, wages and position and statement of financial performance. The
depreciation. statements are linked because the recognition of an item in
one statement requires the recognition of the same item in
Losses do not arise in the course of the ordinary regular another statement.
activities and include losses resulting from disasters.
For example, the recognition of income happens
Examples include losses from fire, flood, storm surge, simultaneously with the recognition of an increase in asset
tsunami and hurricane, as well as those arising from or decrease in liability. The recognition of expense happens
disposal of noncurrent assets. simultaneously with the recognition of a decrease in asset
or increase in liability.

RECOGNITION CRITERIA

Only items that meet the definition of an asset, a liability or

equity are recognized in the statement of financial position.
Similarly, only items that meet the definition of income or
expense are recognized in the statement of financial
performance.

In addition to meeting the definition of an element, items are

recognized only when their recognition provides users of
financial statements with information that is both relevant
and faithfully represented.

Recognition does not focus anymore on how probable

economic benefits will flow to or from the entity and that the
cost can be measured reliably. An asset or liability and any
corresponding income or expense can exist even if the
probability of inflow or outflow of the benefits is low.

POINT OF SALE INCOME RECOGNITION

The basic principle of income recognition is that income

shall be recognized when earned.

But the question is when is income considered to be

earned? With respect to sale of goods in the ordinary
course of business, the point of sale is unquestionably the
point of income recognition. The reason is that it is at the
point of sale that the entity has transferred to the buyer the
significant risks and rewards of ownership of the goods.

Stated differently, legal title to the goods passes to the

buyer at the point of sale.

Moreover, it is at the point of sale that the entity has

transferred control of the goods to the customer.

However, under certain conditions, income may be

recognized at the point of production, during production and
at the point of collection.
EXPENSE RECOGNITION IMMEDIATE RECOGNITION

The expense recognition principle means that expenses Under this principle, the cost incurred is expensed outright
are recognized when incurred. because of uncertainty of future economic benefits or
difficulty of reliably associating certain costs with future
But the question is when are expenses incurred? Actually, revenue.
the expense recognition principle is the application of the
matching principle. The generation of revenue is not without An expense is recognized immediately:
any cost. There has got to be some cost in earning a
revenue. There is no gain if there is no pain. a. When an expenditure produces no future economic
benefit.
The matching principle requires that those costs and b. When cost incurred does not qualify or ceases to qualify
expenses incurred in earning a revenue shall be reported for recognition as an asset.
in the same period.
Examples include officers' salaries and most administrative
The matching principle or expense recognition principle has expenses, advertising and most selling expenses, amount
three applications, namely: to settle lawsuit and worthless intangibles.

a. Cause and effect association Many losses, such as loss from disposal of building, loss
b. Systematic and rational allocation from sale of investments, and casualty loss, are
c. Immediate recognition immediately recognized because they are not directly
related to specific revenue
CAUSE AND EFFECT ASSOCIATION
DERECOGNITION
Under the cause and effect association, the expense is
recognized when the revenue is already recognized. The Revised Conceptual Framework introduced the term
derecognition.
The reason is the presumed direct association of the
expense with specific income. The cause and effect Derecognition is defined as the removal of all or part of a -
association principle is actually the strict matching concept. recognized asset or liability from the statement of financial
position.
This matching process, commonly referred to as the
matching of cost with revenue, involves the simultaneous Derecognition normally occurs when an item no longer
or combined recognition of revenue and expenses that meets the definition of an asset or a liability.
result directly and jointly from the same transactions or
events. Derecognition of an asset occurs when the entity loses
control of all or part of the asset.
The best example is the cost of merchandise inventory.
Derecognition of a liability occurs when the entity no longer
Such cost is considered as an asset in the meantime that has a present obligation ion for all or part of the liability.
the merchandise is on hand. When the merchandise is sold,
the cost is expensed in the form of cost of goods sold MEASUREMENT
because at such time revenue can now be recognized.
Measurement is defined as quantifying in monetary terms
Other examples include doubtful accounts, warranty the elements in the financial statements.
expense and sales commissions.
The Revised Conceptual Framework mentions two
SYSTEMATIC AND RATIONAL ALLOCATION categories:

Under systematic and rational allocation, some costs are Historical cost
expensed by simply allocating them over the periods Current value
benefited.
HISTORICAL COST
The reason for this principle is that the cost incurred will
benefit future periods and that there is an absence of a The historical cost or original acquisition cost of an asset is
direct or clear association of the expense with specific the cost incurred in acquiring or creating the asset
revenue. When economic benefits are expected to arise comprising the consideration paid plus transaction cost.
over several accounting periods and the association with
income can only be broadly or indirectly determined, The historical cost of a liability is the consideration received
expenses are recognized on the basis of systematic and to incur the liability minus transaction cost.
allocation procedures.
Simply stated, historical cost is the entry price or entry value
Concrete examples include depreciation of property, plant to acquire an asset or to incur a liability.
and equipment, amortization of intangibles, and allocation
of prepaid rent, insurance and other prepayments.
An application of the historical cost measurement is to FULFILLMENT VALUE
measure financial asset and financial liability at amortized
cost. Fulfillment value is the present value of cash that an entity
expects to transfer in paying or settling a liability.
The amortized cost reflects the estimate of future cash
flows discounted at a rate determined at initial recognition. Fulfillment value does not include transaction cost on
incurring a liability but includes transaction cost on
HISTORICAL COST UPDATED fulfillment of a liability.

1. Historical cost of an asset is updated because of: Fulfillment value is an exit price or exit value.
a. Depreciation and amortization
b. Payment received as a result of disposing part or all of CURRENT COST
the asset
c. Impairment Current cost of an asset is the cost of an equivalent asset
d. Accrual of interest to reflect any financing component of at the measurement date comprising the consideration paid
the asset and transaction cost.
e. Amortized cost measurement of financial asset
Current cost of a liability is the consideration that would be
2. Historical cost of a liability is updated because of: received less any transaction cost at measurement date.
a. Payment made or satisfying an obligation to deliver
goods Similar to historical cost, current cost is also based on the
b. Increase in value of the obligation to transfer economic entry price rice or entry value but reflects market conditions
resources such that the liability becomes onerous on measurement date.
c. Accrual of interest to reflect any financing component of
the liability SELECTING A MEASUREMENT BASIS
d. Amortized cost measurement of financial liability
In selecting a measurement basis for an asset or a liability
CURRENT VALUE and for the related income and expense, it is necessary to
consider the nature of the information that the
Current value includes: measurement basis will produce.
Fair value
Value in use for asset In most cases, no single factor will determine which
Fulfillment value for liability measurement basis should be selected.
Current cost
The relative importance of each factor will depend on facts
FAIR VALUE and circumstances.

Fair value of an asset is the price that would be received to The information produced by the measurement basis must
sell an asset in an orderly transaction between market be useful to the users of financial statements.
participants at measurement date.
To achieve this, the information must be both relevant and
Fair value of liability is the price that would paid to transfer faithfully represented.
a liability in an orderly transaction between market
participants at the measurement date. Historical cost is the measurement basis most commonly
adopted in preparing financial statements.
Fair value is an exit price or exit value. Fair value can be
observed directly using market price of the asset or liability In many situations, it is simpler and less costly to measure
in an active market. In cases where fair value cannot be historical cost than it is to measure a current value.
directly measured, an entity can use present value of cash
flows. Fair value is not adjusted for transaction cost. The In addition, historical cost is generally well understood and
reason is that such cost is a characteristic of the transaction verifiable.
and not of the asset or liability.
The IASB did not mandate a single measurement basis
VALUE IN USE because the different measurement bases could produce
useful information under different circumstances.
Value in use is the present value of the cash flows that an
entity expects to derive from the use of an asset and from
the ultimate disposal.

Value in use does not include transaction cost on acquiring

the asset but includes transaction cost on the disposal of
the asset.

Value in use is an exit price or exit value.

Fulfillment value
CHAPTER 7 (CONCEPTUAL FRAMEWORK- All income and expenses should be appropriately classified
PRESENTATION AND DISCLOSURE CONCEPTS and included in the income statement. However, there are
OF CAPITAL) certain items of income and expenses that are presented
outside of profit or loss but included in other comprehensive
income.
PRESENTATION AND DISCLOSURE
The components of other comprehensive income are
The presentation and disclosure can be an effective
subsequently recycled or reclassified either to profit or loss
communication tool about the information in financial
or retained earnings.
statements.

A reporting entity communicates information about its AGGREGATION

assets, liabilities, equity, income and expenses by
Aggregation is the adding together of assets, liabilities,
presenting and disclosing information in the financial
equity, income and expenses that have similar or shared
statements.
characteristics and are included in the same classification.
Effective communication of information in financial
Aggregation makes information more useful by
statements makes the information more relevant and
summarizing a large volume of detail. However,
contributes to faithful representation of an entity's assets
aggregation may conceal some of the detail.
liabilities, income and expenses. It also enhances the
understandability and comparability of information in the
Hence, a balance should be made so that relevant
financial statements. It is supported by not duplicating
information is not obscured either by a large amount of
information in different parts of the financial statements.
insignificant detail or by excessive aggregation.
Duplication is usually unnecessary and can make financial
Typically, the statement of financial position and the
statements less understandable.
statement of financial performance provide summarized or
CLASSIFICATION condensed information.

More detailed information is provided in the notes to

Classification is the sorting of assets, liabilities, equity,
financial statements.
income and expenses on the basis of shared or similar
characteristics.
CAPITAL MAINTENANCE
Classifying dissimilar assets, liabilities, equity, income and
The financial performance of an entity is determined using
expenses can obscure relevant information, reduce
two approaches, namely transaction approach and capital
understandability and comparability and may not provide a
maintenance approach.
faithful representation of financial information.
The transaction approach is the traditional preparation of an
For example, it could be appropriate to classify an asset or
income statement.
a liability into current and noncurrent.

It may be necessary to classify components of equity The capital maintenance approach means that net income
occurs only after the capital used from the beginning of the
separately if such components are subject to legal,
period is maintained.
regulatory and other requirements.
In other words, net income is the amount an entity can
Thus, ordinary share capital, preference share capital,
distribute to the owners and be as "well-off" at the end of
share premium and retained earnings should be disclosed
the year as at the beginning.
separately.

CLASSIFICATION OF INCOME AND EXPENSES The Conceptual Framework considered two concepts of
capital maintenance or well-offness, namely financial
Income and expenses are classified as components of capital and physical capital.
profit loss and components of other comprehensive
income. FINANCIAL CAPITAL

The Revised Conceptual Framework has introduced the Under a financial capital concept, capital is synonymous
with net assets or equity of the entity based on historical
term statement of financial performance to refer to the
income statement together with the statement presenting cost.
other comprehensive income.
Financial capital is the monetary amount of the net assets
contributed by shareholders and the amount of the increase
The income statement or statement of profit or loss is the
primary source of information about an entity's financial in net assets resulting from earnings retained by the entity.
performance for the reporting period.
GAAP is based on financial capital concept and does not
require adjustments for price level change.

Under the financial capital concept, capital is maintained

when the entity has positive earnings for the year.
Under the financial capital concept, capital is maintained PHYSICAL CAPITAL
when the entity has positive earnings for the year.
Physical capital is the quantitative measure of the physical
When an entity has income, it has recognized revenue productive assets to produce goods and services.
sufficient to replace all resources used in generating that
revenue. The physical capital concept requires that productive
assets be measured at current cost, rather than historical
Such income could then be distributed as dividends without cost.
eroding the capital or net assets existing at the beginning of
the year. Productive assets include inventories and property, plant
and equipment.
As a simple example, an entity used up resources of
P500,000 in generating revenue for the year. The current costs for these productive assets must be
maintained in order that physical capital is also maintained.
Under the financial capital concept, the cost of P500,000
would be used in measuring revenue. Accordingly, physical capital is equal to the net assets of
the entity expressed in terms of current cost.
If the revenue for the current year is also P500,000 and the
entity had no other expenses, net income would be zero As a simple example, an entity used up resources costing
and capital would just be maintained. P500,000 in generating revenue for the year but P550,000
would be needed to replace the resources used.
NET INCOME UNDER FINANCIAL CAPITAL
Under the physical capital concept, the entity would need
Under the financial capital concept, net income occurs revenue of P550,000 in order to maintain the capital at the
when the nominal amount of the net assets at the end of beginning of the year.
the year exceeds the nominal amount of the net assets at
the beginning of the period, after excluding distributions to NET INCOME UNDER PHYSICAL CAPITAL CONCEPT
and contributions by owners during the period.
Under physical capital concept, net income occurs when
the physical productive capital of the entity at the end of the
year al of t exceeds the physical productive capital at the
beginning of the period, also after excluding distributions to
and contributions from owners during the period.