DEFINITION OF ACCOUNTING INTERNAL TRANSACTIONS

Accounting Standards Council • Are economic events involving one entity only.
• Accounting is a service activity. • Are economic activities that take place entirely
• The accounting function is to provide within the entity.
quantitative information, primarily financial in • Production and casualty loss are examples of
nature, about economic entities, that is intended internal transactions.
to be useful in making economic decisions. • Production is the process by which resources are
American Institute of Certified Public Accountant transformed into products.
• Accounting is the art of recording, classifying, • Casualty is any sudden and unanticipated loss
and summarizing in a significant manner and in from fire, flood, earthquake and any other event
terms of money, transactions and events which ordinarily termed as act of God.
are in part at least of a financial character and MEASURING
interpreting results thereof. • Is the assigning of peso amounts to the
AMERICAN ACCOUNTING ASSOCIATION accountable economic transactions and events.
• Accounting is the process of identifying, • Accounting information must be expressed with
measuring, and communicating economic a common financial denominator.
information to permit informed judgement and • Philippine peso is the unit of measuring
decision by users of the information. accountable economic transactions.
IMPORTANT POINTS IN THE DEFINITION OF ACCOUNTING • The measurement bases are historical cost and
1. Accounting is about quantitative information. current value.
2. The information is likely to be financial in • Historical cost is the most common measure of
nature. financial transactions.
3. the information should be useful in decision
• Current value includes fair value, value in use,
making.
fulfillment value and current cost.
“The very purpose of accounting is to provide
COMMUNICATING
quantitative information to be useful in making
• is the process of preparing and distributing
economic decisions”
accounting reports to potential users of
accounting information.
COMPONENTS OF ACCOUNTING
• Identifying and measuring are pointless if the
1. Identifying – analytical component.
information contained in the accounting records
2. Measuring – technical component.
cannot be communicated in some form to
3. Communicating – formal component.
potential users.
IDENTIFYING
• Communicating is the reason why accounting
• Is the recognition or non-recognition of business
has been called the “Universal language of
activities as accountable events.
business”.
• Not all business activities are accountable.
• Implicit in the communication process are the
• An event is accountable or quantifiable when it
recording, classifying and summarizing aspects
has an effect on assets, liabilities, and equity.
of accounting.
• The subject matter of accounting is economic
• Recording or Journalizing is the process of
activity or the measurement of economic
systematically maintaining a record of all
resources and economic obligations.
economic business transactions after they have
INTERNAL AND EXTERNAL TRANSACTIONS
been identified and measured.
External transactions
• Classifying is the sorting of grouping of similar
• Are those economic events involving one entity
and interrelated economic transactions into
and another entity.
their respective classes. Classifying is
Examples:
accomplished by posting to the ledger
1. Purchase of goods from a supplier
• Ledger is a group of accounts which are
2. Borrowing money from the bank
systematically categorized into asset accounts,
3. Sale of goods to a customer
liability accounts, equity accounts, revenue
4. Payment of salaries of employees
accounts and expense accounts.
5. Payment of taxes to the government
• Summarizing is the preparation of financial
statements. STATEMENTS!
ACCOUNTING AS AN INFORMATION SYSTEM ACCREDITATION OF THE PRACTICE OF PUBLIC ACCOUNTANCY
• Accounting is an information system that • CPAs, firms and partnerships of CPAs, including
measures business activities, process partners and staff members are required to
information into reports and communicates the register with the Board of Accountancy and PRC
reports to decision makers. for the practice of public accountancy.
• A key product of this information system is a set • The issued PRC certificate of registration shall be
of financial statements – the document that valid for three (3) years and renewable every
report financial information about an entity to three years upon payment of required fees.
decision makers. Three main areas of practice (CPA)
• Financial reports tell us how well an entity is • Public accounting
performing in terms of profit and loss and where • Private accounting
it stands in financial terms. • Government accounting
OVERALL OBJECTIVE OF ACCOUNTING PUBLIC ACCOUNTING
• Provide quantitative financial information about • Is composed of individual practitioners, small
a business that is useful to statement users accounting firms and large multinational
particularly owners and creditors in making organizations that render independent and
economic decisions. expert financial services to the public.
• An accountant’s primary task is to supply • Offers three (3) kinds of services, namely
financial information so that the statement users auditing, taxation and management advisory
could make informed judgement or better services.
decision. AUDITING
• The essence of accounting is decision- • Primary service offered by most public
usefulness. accounting practitioners.
THE ACCOUNTANCY AS A PROFESSION • Or external auditing is the examination of
• Republic act 9298 is the law regulating practice financial statements by independent certified
of accountancy in the Philippines. public accountant for the purpose of expressing
• The law is known as ”Philippine Accountancy Act an opinion as to the fairness with which the
of 2004” financial statements are prepared.
• Board of Accountancy is the body authorized by • Attest function of independent CPAs.
the law to promulgate rules and regulations TAXATION
affecting the practice of the accountancy • Taxation service includes the preparation of
profession in the Philippines. annual income tax returns and determination of
• Board of Accountancy is responsible for tax consequences of certain proposed business
preparing and grading the Philippine CPA endeavors.
examination. MANAGEMENT ADVISORY SERVICES
• Exam is offered twice a year. May and October. • Management advisory services is used generally
LIMITATION OF THE PRACTICE OF PUBLIC ACCOUNTANCY to refer to services to clients on matters of
• Single practitioners and partnerships for the accounting, finance, business policies,
practice of public accountancy shall be organization procedures, product cost,
registered certified public accountants in the distribution and many other phases of business
Philippines. conduct operations.
• A certificate of accreditation shall be issued to Management advisory includes:
certified public accountants in public practice 1. Advice on installation of computer system
only upon showing in accordance with the rules 2. Quality control
and regulations promulgated by the Board of 3. Installation and modification of accounting
accountancy and approved by the Professional system.
Regulation Commission that such registrant has 4. Budgeting
acquired a minimum of three (3) years of 5. Forward planning and forecasting
meaningful experience in any areas of public 6. Design and modification of retirement plans
practice including taxation. 7. Advice on mergers and consolidation
• The Securities and Exchange Commission shall
not register any corporation organized for the
practice of public accountancy.
PRIVATE ACCOUNTING • CPD has become mandatory for CPA
• Many CPAs are employed in a business entity in • CPD is required for the renewal of CPA license
various capacity as accounting staff, chief and accreditation of CPA to practice the
accountant, internal auditor, and controller. accountancy profession.
• Controller – highest accounting officer in an EXEMPTION FROM CPD
entity. • A CPA shall be permanently exempted from CPD
• Major objective is to assist management in requirements upon reaching the age of 65 years.
planning and controlling the entity’s operations. • This exemption is applied only to the renewal of
• Includes maintaining the records, producing the CPA license and not for the purpose of
financial reports, preparing the budgets and accreditation to practice the Accountancy
controlling and allocating the resources of the profession.
entity. ACCOUNTING VS. AUDITING
• Also responsible for the determination of the • Accounting embraces auditing
various taxes the entity is obliged to pay. • Auditing is one of the areas of accounting
GOVERNMENT ACCOUNTING specialization.
• Encompasses the process of analyzing, • Accounting is constructive in nature
classifying, summarizing, and communicating all • Accounting ceases when financial statements
transactions involving the receipt and are already prepared.
disposition of government funds and property • Auditing is analytical.
and interpreting the results thereof. • The work of an auditor begins when the work of
• The focus of government accounting is the accountant ends.
custody and administration of public funds. • After the financial statements are prepared, the
Branches of the government with accountants: auditor will begin to perform the task of auditing.
a) Bureau of Internal Revenue • The auditor examines the financial statements to
b) Commission on Audit ascertain whether they are in conformity with
c) Department of Budget and Management generally accepted accounting principles.
d) Securities and Exchange Commission ACCOUNTING VS. BOOKKEEPING
e) Bangko Sentral ng Pilipinas • Bookkeeping is procedural
CONTINUING PROFESSIONAL DEVELOPMENT (CPD) • Bookkeeping is the “how” of accounting
• Republic Act No. 10912 Is the law maintaining • Accounting is the conceptual and is concerned
and strengthening the continuing professional with the “why”, reason or justification for any
development program for all regulated actin adopted.
professions, including the accountancy • Bookkeeping is a procedural element of
profession. accounting as arithmetic is a procedural element
• CPD refers to the inculcation and acquisition of of mathematics.
advanced knowledge, skill, proficiency and ACCOUNTING VS. ACCOUNTANCY
ethical moral values after the initial registration • Broadly speaking, these terms are synonymous.
of the Certified Public Accountant for • Both refer to the entire field of accountancy
assimilation into professional practice and theory and practice.
lifelong learning.
• Accountancy refers to the profession of
• CPD raises and enhances the technical skill and accounting practice.
competence of the Certified Public Accountant.
• Accounting is used as a reference only to a
CPD CREDIT UNITS
particular field of accountancy such as public
• CPD credit units refer to the CPD credit hours accounting, private accounting and government
required for the renewal of CPA license and accounting.
accreditation of a CPA to practice the FINANCIAL ACCOUNING VS. MANAGERIAL ACCOUNTING
accountancy profession every 3 years. • Financial accounting is primarily concerned with
• Regardless of the sector, practice shall be the recording of business transactions and the
required to comply with 120 CPD credit units in eventual preparation of financial statements.
a compliance period of three years, • Financial accounting focuses on general purpose
• Excess credit units earned shall not be carried reports known as financial statements intended
over to the next three-year period unless it is for internal and external users.
earned for masteral and doctoral degrees.
 • Financial accounting is the area of accounting COMPOSITION OF FRSC
that emphasizes reporting to creditors and • Composed of 15 members.
investors. • The chairman and members of the FRSC shall
• Managerial accounting is the accumulation and have a term of 3 years renewable for another
preparation of financial reports for internal users term.
only. PHILIPPINE INTRPRETATIONS COMMITTEE
• Managerial accounting is the area of accounting • Formed by the FRSC in August 20006 and has
that emphasizes developing accounting replaced the interpretations Committee formed
information for use within an entity. by the ASC in May 2000
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) • The role of PIC is to prepare interpretations of
• Are the accounting rules, procedures, practices. PFRS for approval by the FRSC and to provide
• Developed on the basis of experience, reason, timely guidance on financial reporting issues not
custom, usage and practical necessity. specifically addressed in the current PFRS.
• Represent the rules, procedures, practice and • Interpretations are intended to give
standards followed in the preparation and authoritative guidance on issues that are likely to
presentation of financial statements. receive divergent or unacceptable treatment
• Laws that must be followed in financial because the standards do not provide specific
reporting. and clear-cut rules and guidelines.
• The process of establishing GAAP is a political • The counterpart of the PIC in the UK is the
process which incorporates political actions of International Financial Reporting
various interested user group as well as Interpretations committee or IFRIC which has
professional judgement, logic and research. already replaced the Standing Interpretations
PURPOSE OF ACCOUNTING STANDARDS Committee. SIC
• To identify proper accounting practices for the INTERNATIONAL ACCOUNTING STANDARDS
preparation and presentation of financial statements. COMMITTEE
• Accounting standards create a common
• Is an independent private sector body, with the
understanding between preparers and users of
financial statements particularly the measurement of
objective of achieving uniformity in the
assets and liabilities accounting principles which are used by business
• A set of high quality accounting standards is a and other organizations for financial reporting
necessity to ensure comparability and uniformity in around the world
financial statements based on the same financial • Formed in June 1973.
information. • Headquartered in London, UK
FINANCIALREPORTING STANDARDS COUNCIL (FRSC) OBJECTIVES OF IASC
• GAAP is initially formulized through creation of • To formulate and publishing the public interest
the Accounting Standards Council (ASC). accounting standards to be observed in the
• FRSC replaces ASC presentation of financial statements and to
• FRSC is the accounting standard setting body promote their worldwide acceptance and
created by the PRC upon the recommendation of observance.
the Board of Accountancy in carrying out its • To work generally for the improvement and
powers and functions under R.A. Act N0. 9298 harmonization of regulations, accounting
• Main function is to establish and improve standards and procedures relating to the
accounting standards that will be generally presentation of financial statements.
accepted in the Philippines. INTERNATIONAL ACCOUNITNG STANDARDS BOARD
• The accounting standards promulgated by the • This replaces the IASC
FRSC constitute the “highest hierarchy” of GAAP • IASB publishes standards in a series of
in the Philippines. pronouncements called International Financial
• The approved statements of FRSC are known as Standards Committee or IFRS
Philippine Accounting Standards (PAS) and • has adopted the body of standards issued by
Philippine Financial Reporting Standards IASC
(PFRS). • The pronouncements of IASC continue to be
designated as “International Accounting
Standards” or IAS
 • The IASB standard-setting process includes in the The PAS are numbered the same as their
correct order research, discussion paper, counterpart in IAS.
exposure draft and accounting standard. c. Philippine interpretations which correspond to
MOVE TOWARD IFRS interpretations of the IFRIC and the Standing
• Standards issued by other standard-setting Interpretations Committee, and Interpretations
bodies such as the USA Financial Accounting developed by the Philippine Interpretations
Standards Board (FASB) and the IASB are committee.
considered in developing accounting standards
that will generally accepted in the Philippines. CHAPTER 2
• In the past years, Philippine standards issued are CONCEPTUAL FRAMEWORK
based on the American Accounting Standard. • The Conceptual Framework for financial
• At present, the FRSC has adopted in their reporting is a complete, comprehensive, and
entirely all International Accounting standards single document promulgated by the
and International Financial Reporting Standards. International Accounting Standards Board.
• The move towards IFRSC is essential to achieve • Is a summary of the terms and concepts that
the goal of one uniform and globally accepted underlie the preparation and presentation of
financial reporting standards. financial statements for external users.
• The Philippines is fully compliant with IFRS • Describes the concepts for Generally Purpose
effective January 2005, a process which was Financial Reporting.
started back in 1997 in moving from USA GAAP • Is an attempt to provide an overall theoretical
to IFRS/ foundation for accounting.
FACTORS TO BE CONSIDERED IN DECIDING TO MOVE • Is intended to guide standard-setters, preparers
TOTALLY TO INTERNATIONAL ACCOUNTING STANDARDS: and users of financial information in the
a. Support of international accounting standards by preparation and presentation of statements.
Philippine organizations such as the Philippine • Conceptual Framework is the underlying theory
SEC, Board of Accountancy and PICPA. for the development of accounting standards
b. Increasing internalization of business which has and revision of previously issues accounting
heightened the interest in a common language standards.
for financial reporting. • Conceptual Framework will be used in future
c. Improvement of international accounting standard-setting decision but no changes will be
standards or removal of free choices of made to the current IFRS.
accounting treatments. THE CONCEPTUAL FRAMEWORK PROVIDES THE
d. Increasing recognition of international FOUNDATION FOR STANDARDS THAT:
accounting standards by the World Bank, Asian a. Contribute to transparency
Development Bank and World Trade b. Strengthen accountability
Organization. c. Contribute to economic efficiency
PHILIPPINE FINANCAL REPORTING STANDARDS PURPOSES OF REVISED CONCPTUAL FRAMEWORK
• The Financial Reporting Standards Council issues a. To assist the IASB to develop IFRS standards
standards in a series of pronouncements called based on consistent concepts.
“Philippine Financial Reporting Standards” or b. To assist preparers of financial statements to
PFRS develop consistent accounting policy when no
PFRS COLLECTIVELY INCLUDE ALL OF THE FOLLOWING: Standard applies to a particular transaction or
a. Philippine Financial Reporting Standards which other event or when an issue is not yet
correspond to the International Financial addressed by an IFRS.
Reporting Standards. c. To assist preparers of financial statements to
develop accounting policy when a standard
The PFRS are numbered the same as their allows a choice of an accounting policy.
counterpart in IFRS. d. To assist all parties to understand and interpret
b. Philippine Accounting Standards which the IFRS standards.
correspond to International Accounting
Standards
AUTHORITATIVE STATUS OF CONCEPTUAL FRAMEWORK but the reports are not directed to them
• If there is a standard or an interpretation that primarily.
specifically applies to a transaction, the standard Employees
or interpretation overrides the conceptual • Are interested in information about the stability
framework. and profitability of the entity
• In the absence of a standard or an interpretation • The employees are interested in information
that specifically applies to a transaction, which enables them to assess the ability of the
management shall consider the applicability of entity to provide remuneration, retirement
the conceptual framework in developing and benefits, and employment opportunities.
applying an accounting policy that results in Customers
information that is relevant and reliable. • Have an interest in information about the
• Conceptual Framework is not An International continuance of an entity especially when they
Financial Reporting Standard. have a long-term involvement with or are
• Nothing in the Conceptual Framework overrides dependent on the entity.
any specific IFRS. Government and their agencies
• In case of conflict, The International Financial • Government and their agencies are interested in
Reporting Standards shall prevail over the the allocation of resources and therefore the
conceptual framework. activities of the entity.
USERS OF FINANCIAL INFORMATION • These users require information to regulate the
Under the Conceptual Framework for financial reporting, activities of the entity, determine taxation
the users of financial information are classified into two: policies, and as a basis for national income and
1. Primary users similar statistics.
2. Other users Public
Primary users • Entities affect members of the public in variety
• Includes the existing and potential investors, of ways.
lenders and other creditors. • Entities make substantial contribution to the
• Are the parties to whom general purpose local economy in many ways including the
financial reports are primarily directed. number of people they employ and their
• Such users cannot require reporting entities to patronage of local suppliers.
provide information directly to them and • Financial statements may assist the public by
therefore must rely on general purpose financial providing information about the trend and the
reports for much of the financial information range of its activities.
they need. SCOPE OF REVISED CONCEPTUAL FRAMEWORK
Existing and Potential Investors a. Objective of financial reporting
• Are concerned with the risk inherent in and b. Qualitative characteristics of useful financial
return provided by their investment. information
• Investors need information to help them c. Financial statements and reporting entity
determine whether they should buy, hold or sell d. Elements of financial statements
• Shareholders are also interested in information e. Recognition and derecognition
which enable them to assess the ability of the f. Measurement
entity to pay dividends. g. Presentation and disclosure
Lenders and Other Creditors h. Concepts of capital and capital maintenance
• Existing and potential lenders and other A. OBJECTIVE OF FINANCIAL REPORTING
creditors are interested in information which • The objective of financial reporting forms the
enables them to determine whether their loans, foundation of conceptual framework.
interests thereon and other amounts owing • The overall objective of financial reporting is to
them will be paid when due. provide financial information about the
Other users reporting entity that is useful to existing and
• Are users of financial information other than the potential investors, lenders and other creditors
existing and potential investors, lenders and in making decision about providing resources to
other creditors. the entity.
• Are so called because they are parties that may • The objective of financial reporting is the “why”,
find the general purpose financial reports useful purpose or goal of accounting.
 • Financial Reporting is the provision of financial Economic decisions
information about an entity to external users • Existing and potential investors need general
that is useful to them in making economic purpose financial reports in order to enable
decisions and for assessing he effectiveness of an them in making decisions whether to buy, sell or
entity’s management. hold equity investments
• Financial Reporting encompasses not only • Lenders and other creditors need general
financial statements but also other information purpose financial reports in order to enable
such as financial highlights, summary of them in making decisions whether to provide or
important financial figures, analysis of financial settle loans and other forms of credit.
statements and significant ratios. Assessing cash flow prospects
• Financial reports also include nonfinancial • Decisions about buying, selling etc. depends on
information such as description of major returns that existing and potential investors
products and listing of corporate officers and expect from an investment.
directors. • Decisions about settling loans and other forms of
Target users credit depends on principal and interest
• Financial reporting is directed primarily to the payments that potential lenders and other
existing and potential investors, lenders and creditors expect from other returns they expect
other creditors which compose the primary user • financial reporting should provide information
group. useful in assessing the amount, timing and
• The reason is that existing and potential uncertainty of prospects for future net cash
investors, lenders and other creditors have the inflows to the entity
most crucial and immediate need for Economic resources and claims
information in financial reports. • General purpose financial reports provide
• The primary users of financial information are information about financial position of a
the parties that provide resources to the entity. reporting entity.
• Information that meets the needs of specified • Financial position is the information about the
primary users is likely to meet the needs of their entity’s economic resources and the claims
users such as employees, customers, against the reporting entity.
government and their agencies. • Economic resources are the assets and the
• The Management of a reporting entity is also claims are the liabilities and equity of the entity.
interested in financial information about the • Financial position comprises the assets,
entity. liabilities, and equity of an entity at a particular
• Management need not rely on general purpose moment in time.
financial reports because it is able to obtain or • Liquidity is the availability of cash in the near
access additional financial information future to cover currently maturing obligations.
internally. • Solvency is the availability of cash over a long
Specific Objectives of financial reporting term to meet financial commitments when they
• The overall objective of financial reporting is to fall due.
provide information that is useful for decision CHANGES IN ECONOMIC RESOURCES AND CLAIMS
making. • General purpose financial reports also provide
• The conceptual framework places more information about the effects of transitions and
emphasis on the importance of providing other events that change the economic
information needed to assess the management resources and claims.
stewardship of the entity’s economic resources. • Changes in economic resources and claims result
Specific objectives of financial reporting: from financial performance and from other
a. To provide information useful in making events or transactions, such as issuing debt or
decisions about providing resources to the entity. equity instruments.
b. To provide information useful in assessing cash • Financial performance of an entity comprises
flow prospects of the entity. revenue, expenses, and net income or loss for a
c. To provide information about entity resources, period of time.
claims, and changes in resources and claims.
 • Financial performance is the level of income CHAPTER 3
earned by the entity through the efficient and QUALITATIVE CHARACTERISTICS
effective use of its resources. • Are the qualities or attributes that make financial
• The financial performance of an entity is also accounting information useful to the others.
known as results of operations and is portrayed • In deciding which information to include in
in the income statement and statement of financial statements, the objective is to ensure
comprehensive income. that the information is useful to the users in
Usefulness of financial performance making economic decisions.
• Information about financial performance helps • Decisions about buying, selling etc. depends on
users to understand the return that the entity returns that existing and potential investors
has produced on the economic resources. expect from an investment.
• Information about the return the entity has Classifications of Qualitative characteristics:
produced provides an indication on how well a. Fundamental Qualitative Characteristics
management has discharged its responsibilities b. Enhancing Qualitative Characteristics
to make efficient and effective use of the entity’s Fundamental Qualitative Characteristics
economic resources. a. Relevance
• Information about past financial performance is b. Faithful representation
usually helpful in predicting the future returns • Information must be both relevant and faithfully
on the entity’s economic resource. represented if it is to be useful
• information about financial performance during Application of qualitative characteristics
a period is useful in assessing the entity’s ability 1. Identify an economic phenomenon that has the
to generate future cash inflows from operations. potential to be useful
Accrual accounting 2. Identify the type of information about the
• Accrual accounting means that income is phenomenon that would be most relevant and
recognized when earned regardless of when can be faithfully represented.
received and expense is recognized when 3. Determine whether the information is available.
incurred regardless of when paid. Relevance
Limitations of financial reporting • is the capacity of the information to influence a
a. General purpose financial reports do not and decision.
cannot provide all of the information that • To be relevant, the financial information must be
existing and potential investors, lenders and capable of making a difference in the decisions
other creditors need. made by users.
b. General purpose financial reports are not • Relevance requires that the financial
designed to show the value of an entity but the information should be related or pertinent to the
reports provide information to help primary economic decisions.
users estimate the value of an entity. • Information that does not bear on an economic
c. General purpose financial reports are intended decision is useless.
to provide common information to users and • Information must be relevant to the decision
cannot accommodate every request for making needs of the users.
information Ingredients of relevance
d. To large extent, general purpose financial • Financial information is capable of making
reports are based on estimate and judgement difference if it has predictive value and
rather than exact depiction. confirmatory value.
Management stewardship • Financial information has predictive value if it
• Information about how effectively management can be used as an input to processes employed
has discharged its responsibilities to use the by users to predict future outcome.
entity’s economic resources helps users to assess • Financial information has predictive value when
management stewardship of those resources. it can help users increase the like hood of
• Such information is useful for predicting how correctly or accurately predicting or forecasting
management will use the entity’s economic outcome of events.
resources in future periods. • Financial information has confirmatory value if it
• the information can be useful for assessing provides feedback about previous evaluations.
entity’s prospects for the future net cash flows.
 • Financial information has confirmatory value Factors of materiality
when it enables users confirm or correct earlier • In the exercise of judgement in determining
expectations. materiality, the relative size and nature of an
• Often, Information has both predictive and item is considered.
confirmatory value, • The size of an item in relation to the total of the
• The predictive and confirmatory roles of group to which the item belong is taken into
information are interrelated. account.
Materiality • The nature of an item may be inherently material
• Materiality is a practical rule in accounting which because by its very nature it affects economic
dictates that strict adherence to GAAP is not decision.
required when the items are not significant Faithful representation
enough to affect evaluation, decision and • Faithful representation means that financial
fairness of the financial statements. reports represent economic phenomena or
• The materiality concept is also known as the transactions in words and numbers.
Doctrine of Convenience • The descriptions and figures must match what
• Materiality is really a quantitative “threshold” really existed or happened.
linked very closely to the qualitative • Faithful representation means that the actual
characteristic of relevance. effects of the transactions shall be properly
• The relevance of information is affected by its accounted for and reported in the financial
nature and materiality. statements.
• Materiality is a sub quality of relevance based on Ingredients of faithful representation
the nature or magnitude or both of the items to a. Completeness
which the information relates. b. Neutrality
• The conceptual framework does not specify a c. Free from error
uniform quantitative threshold for materiality or Completeness
predetermine what could be material in a • Completeness requires that relevant
particular situation. information should be presented in a way that
Materiality is a relativity facilitates understanding and avoids erroneous
• Materiality of an item depends on the relative implication.
size rather than absolute size. • Completeness id the result of the adequate
• What material for one entity may be immaterial disclosure standard or the principle of full
for another. disclosure.
• Example: 100k is small for SM but for small • A complete depiction includes all information
businesses, its malaki like wth. San sila mag get necessary for a user to understand the
ng 100k in an instant unlike SM na may big kita phenomenon being depicted, including all
every day. necessary descriptions and explanations.
When is an item material? Standard of adequate disclosure
• “An item is material if knowledge of it would • Standard of adequate disclosure means that all
affect or influence the decision of the informed significant and relevant information leading to
users of the financial statements.” the preparation of financial statements shall be
• There is no strict or uniform rule for determining clearly reported.
whether the item is material or not • The accountant shall disclose a material fact
• Very often, this is dependent on good known to him which is not disclosed in the
judgement, professional expertise and common financial statements but disclosure of which is
sense. necessary in order that the financial statements
• Information is material if its omission or would not be misleading.
misstatement could influence the economic • The standards of adequate disclosure is best
decision that the users make on the basis of the described by disclosure of any financial facts
financial information about an entity. significant enough to influence the judgement
of the informed users.
Notes to financial statements Expressions of Conservatism
• To be complete, the financial statements shall be • “Anticipate no profit and provide for
accompanied by “notes to financial statements” probable and measurable loss”
• the purpose of the notes is to provide necessary • “In the matter of income recognition, the
disclosures required by Philippine Financial
accountant takes the position that no matter
Reporting Standards.
how sure the business man might be in
Neutrality
capturing the bird in the bush, he, the
• A neutral depiction is without bias in the
accountant, must see it in hand”
preparation or presentation of financial
• “Don’t count your chicks until the eggs
information.
hatch”
• A neutral depiction is not slanted, weighted,
Free from error
emphasized, de-emphasized or otherwise
• Free from error means there are no errors or
manipulated to increase the probability that
omissions in the description of the
financial information will be received
phenomenon or transaction.
favorably or unfavorably by users.
• The process used to produce he reported
• To be neutral, the information contained in
the financial statements, must be free from information has been selected and applied
with no errors in the process.
bias.
• Free from error does not mean perfectly
• The financial information should not favor
one party to the detriment of another party. accurate in all aspects.
Measurement uncertainty
• The information is directed to the common
• Measurement uncertainty arises when
needs of many users, and not to the
monetary amounts in financial reports
particular needs of specific user.
cannot be observed directly and must
• Neutrality is synonymous with the all-
instead be estimated.
encompassing principle of fairness
• Measurement uncertainty can affect faithful
• To be neutral is to be fair.
representation if the level of uncertainty in
Prudence
providing an estimate is HIGH.
• Prudence is the exercise of care and caution
• The use of reasonable estimate is an
when dealing with the uncertainties in the
essential part of providing financial
measurement process such that assets or
information and does not undermine the
income are not overstated and liabilities or
usefulness of the financial information.
expenses are not understated.
• As long as the estimate is clearly and
• Neutrality is supported by the exercise of
accurately described and explained, even a
prudence.
high level of measurement uncertainty does
Conservatism
not affect the usefulness of the financial
• Conservatism is synonymous with prudence.
information.
• Conservatism means that when alternatives
Substance over form
exist, the alternative which has the least
• The economic substance of transactions and
effect on equity should be chosen.
events are usually emphasized when
• Conservatism means “in case of doubt,
economic substance differ from the legal
record any loss and do not record any gain”
form.
• Contingent loss is recognized as a
• Substance over form is not considered a
“provision” if the loss is probable and the separate component of faithful representation
amount can be reliably measured because it would be redundant.
• Contingent gain is not recognized but • Faithful representation inherently represents
disclosed only. the substance of an economic phenomenon or
• It is to be emphasized that conservatism is transaction rather than merely representing
not a license to deliberately understate net legal form.
income and net assets.
 • Representing a legal form that differs from the Consistency
economic substance of the underlying economic • Is not the same as comparability.
phenomenon or transaction could not result in a • in broad sense, consistency refers to the use of
faithful representation. the same method for the same item, either from
Example of substance over form period to period within an entity or in a single
When the lessee leased a property from the lessor. The period across entities.
terms of the lease provide that the lease transfers • Comparability is the goal and consistency helps
ownership from the asset to the lessee by the end of the to achieve that goal.
lease term. • In a limited sense, consistency is the uniform
In form, the contract is a lease as popularly understood. application of accounting method from period to
But in substance, in reality, if the “transfer of ownership period within an entity.
provision” is to be considered, the real intent of the • On the other hand, comparability is the uniform
parties is an installment purchase of an asset by the application of accounting method from period to
lessee from the lessor. period between and across entities in the same
ENHANCING QUALITATIVE CHARACTERISTIC industry.
• The enhancing qualitative characteristics relate • It is inappropriate for an entity to leave
to the presentation or form of the financial accounting policies unchanged when better and
information. acceptable alternatives exists.
• The enhancing qualitative characteristics are Understandability
intended to increase the usefulness of the • Understandability requires that financial
financial information that is relevant and information must be comprehensive and
faithfully represented. intelligible if it is to be most useful.
• Relevant and faithfully represented financial • The information should be presented in a form
information is useful but the information would and expressed in terminology that a user
be most useful if it is comparable, understands.
understandable, verifiable and timely. • Classifying, characterizing and presenting
Enhancing qualitative characteristics: information “clearly and concisely” makes it
a. Comparability understandable.
b. Understandability • An essential quality of the information provided
c. Verifiability in financial statements is that it is readily
d. Timeliness understandable by users.
Comparability • The users shall have an understanding pf the
• Comparability means the ability to bring complex economic activities, financial
together for the purpose of noting points of accounting process and the terminology in the
likeness and difference. financial statements.
• Comparability is the enhancing qualitative • Financial statements cannot realistically be
characteristic that enable users to identify and understandable to everyone.
understand similarities and dissimilarities. • Financial reports are prepared for users who
• Comparability within an entity is the quality of have a reasonable knowledge of business and
information that allows comparisons within a economic activities who review and analyze he
single entity through time or from accounting information diligently.
period to the next • Understandability is very essential because a
• Intracomparability or horizontal comparability relevant and faithfully represented information
is the comparability within an entity would prove useless if it is not understood by
• Intercomparability or dimensional users.
comparability is the comparability across Verifiability
entities. • Verifiability means that different knowledgeable
• For information to be comparable, like things and independent observers can reach
must look alike and different things must look consensus, although not necessarily complete
different. agreement, that a particular depiction is a
• Comparability is not enhanced by making unlike faithful representation.
things look alike or making like things look • Verifiability implies consensus
different.
 • The financial information is verifiable in the • The evaluation of the cost constraint is
sense that it is supported by evidence so that an substantially a judgmental process.
accountant that would look into the same • Assessing whether the cost of reporting
evidence would arrive at the same economic outweighs or falls short of the benefit is difficult
decision or conclusion. to measure and becomes a matter of
• Verifiable information provides results that professional judgement.
would be substantially duplicated by measurers
using the same measurement method.
• Verifiability helps assure users that information CHAPTER 4
represents the economic phenomenon or GENERAL OBJECTIVE OF FINANCIAL STATEMENTS
transaction it purports to represent. • Financial statements provide information about
Types of verification economic resources of the reporting entity,
• Direct verification means verifying an amount or claims against the entity and changes in the
other representation through direct observation, economic resources and claims.
for example, by counting cash.
• Indirect verification means checking the inputs • Financial statements provide financial
to a model, formula or other technique and information about an entity’s asset, liabilities,
recalculating the inputs using the same equity, income and expenses useful to users of
methodology. financial statements in:
Timeliness a. Assessing future cash flows to the
• Timeliness means that financial information reporting entity.
must be available or communicated early b. Assessing management stewardship of
enough when a decision is to be made. the entity’s economic resource.
• Relevant and faithfully represented financial • The financial information is provided in the
information furnished after a decision is made is following:
useless or of no value. 1. Statement of financial position, by
• Generally, the older the information, the less recognizing assets, liabilities and equity.
useful. 2. Statement of financial performance, by
• Some information may continue to be timely recognizing income and expense
long after the end of reporting period because 3. Other statements and notes by
some users may need to identify and assess presenting and disclosing information
trends. about:
• Timeliness enhances the truism that without a. Recognized assets, liabilities,
knowledge of the past, the basis for prediction equity, income and expenses
will usually be lacking and without interest in the b. Unrecognized assets and
future, knowledge of the past is sterile. liabilities
• What happened in the past would become the c. Cash flows
basis of what would happen in the future. d. Contribution from equity
Cost constraint on useful information holders and distribution to
• Cost is a pervasive constraint on the information equity holders
that can be provided by financial reporting. e. Method, assumption and
• Reporting financial information imposes cost judgement in estimating
and it is important that such cost is justified by amount presented.
the benefit derived from the financial Types of financial statements
information. • Consolidated financial statements – these are
• The cost constraint is the consideration of the the financial statements prepared when the
cost incurred in generating financial information reporting entity comprises both the parent and
against the benefit to be obtained from having its subsidiaries.
the information. • Unconsolidated financial statement – these are
• The benefit derived from the information should the financial statements prepared when the
exceed the cost incurred in obtaining the reporting entity is the parent alone.
information. • Combined financial statements - these are the
financial statements when the reporting entity
 comprises two or more entities that are not The following can be considered as a reporting entity:
linked by a parent and subsidiary relationship a. Individual corporation, partnership or
Consolidated financial statements proprietorship
• Consolidated financial statements provide b. The parent alone
information about the assets, liabilities, income c. The parent and its subsidiaries as a single
and expenses of both the parent and its reporting entity
subsidiaries as a single reporting entity. d. Two or more entities without parent and
• The parent is the entity that exercises control subsidiary relationship as a single entity
over the subsidiaries. e. A reportable business segment of an entity
• Consolidated information is useful for existing Reporting period
and potential investors, lenders and other • The reporting period is the period when financia
creditors of the parent in their assessment f statemets are prepared for general purpose
future net cash flows of the parent. financial reporting
• This is because net cash flows to the parent • Financial statements may be prepared on an
include distributions to the parent from its interim basis
subsidiaries. • Interim financial statements are not required but
• Consolidated financial statements are not optional.
designed to provide separate information about • Financial statements must be prepared on an
the assets, liabilities, equity, income and annual basis
expenses of a particular subsidiary • Financial statements are prepared for a specific
• A subsidiary’s own financial statements are period of time and provide information about:
designed to provide such information a. Assets, liabilities and equity at the end of
Unconsolidated financial statements the reporting period
• Unconsolidated financial statements are b. Income and expense during the
deigned to provide information about the accounting period
parent’s assets, liabilities, income and expenses • Financial statements also provide comparative
and not about of the subsidiaries. information at least one preceding reporting
• Such information can be useful to the existing period to identify and assess change in trends.
and potential investors, lenders and other • Financial statements may include information
creditors of the parent because a claim against about transactions and other events that
the parent typically does not give the holder of occurred after the end of reporting period if the
the claim against subsidiaries information is necessary to meet the general
• Information provided in unconsolidated financial objective of financial statements.
statements is typically not sufficient to meet the Underlying assumptions
requirement needs of primary users • Accounting assumptions are the basic notions r
• When consolidated financial statements are fundamental premises on which the accounting
required, unconsolidated financial requirements process is based
cannot serve s substitute. • Accounting assumptions are also known as
Combined financial statements postulates.
• Combined financial statements provide financial • Accounting assumptions serve as the foundation
information about assets, liabilities, equity, or bedrock of accounting in order to avoid
income and expense of two or more entities not misunderstanding but rather enhance the
linked with a parent and subsidiary understanding and usefulness of the financial
relationship. statements.
Reporting entity • the conceptual framework for financial reporting
• A reporting entity is an entity that is required or only mentioned one assumption, namely going
choses to prepare financial statements concern.
• The reporting entity can be a single entity or a • Implicit in accounting are the basic assumptions
portion of an entity, or can comprise more than of accounting entity, time period and monetary
one entity. unit
• A reporting entity is not necessarily a legal
entity.
Going concern • The accounting period may be a calendar
• The going concern or continuity assumption year or a natural business year.
means that in the absence of evidence to the • A calendar year is a twelve-month period
contrary, the accounting entity is viewed as that ends on December 31.
continuing in operation indefinitely. • A Natural business year is a twelve-month
• the going concern postulate is the very period that ends on any month when the
foundation of the cost principle. business is at the lowest or experiencing
• If there is evidence that the entity would slack season.
experience large and persistent losses or Monetary unit
that the entity’s operations are to be • The monetary unit assumption has two
terminated, the going concern assumption is aspects, namely quantifiability and stability
abandoned. of the peso.
Accounting entity • The quantifiability aspect means that the
• In financial accounting, the accounting entity assets, liabilities, equity, income and
is the specific business organization, which expenses should be stated in terms of a unit
may be a proprietorship, partnership or of measure which is peso in the Philippines
corporation. • The stability of the peso assumption means
• Under this assumption, the entity is separate that the purchasing power of peso is stable
from the owners, managers, and employees and constant and that its instability is
who constitute the entity. insignificant and therefore may be ignored
• The reason for the entity assumption is to • The stable peso postulate is actually an
have fair presentation of financial amplification of the going concern
statements assumption so much so that adjustments are
• The personal transactions of the owners unnecessary to reflect any changes in
shall not be allowed to distort the financial purchasing power.
statements of the entity • The accounting function is to account for
• Each business is an independent accounting nominal pesos only and not for constant
entity. pesos or changes in purchasing power.
Time period • There is a significant gap between historical
• A complete accurate report on the financial cost and current replacement cost
position and performance of an entity • An entity may choose the revaluation model
cannot be obtained until the entity is finally as an accounting policy
dissolved and liquidated.
• Users of financial information need timely
information for making an economic
decision
• The time period assumption requires hat the
indefinite life of an entity is subdivided into
accounting periods which are usually of
equal length for the purpose of preparing
financial reports on financial position,
performance and cash flows
• The accounting period or fiscal period is one
year or a period of twelve months
• The “one-year period” is traditionally the
accounting period because usually it is after
one year that the government reports are
required.