Conceptual Framework and Accounting Standards

2nd Semester - Midterm

OVERVIEW OF ACCOUNTING
Accounting - is “the process of identifying, measuring, Ex. changes in fair values, technological changes,
and communicating economic information to permit Internal Events - events that do not involve an external
informed judgment and decisions by users of party.
information.” a. Production - the process by which resources are
Three important activities transformed into finished goods.
1. Identifying - the process of analyzing events and Ex. conversion of raw material into finished products
transactions to determine whether or not they will be b. Casualty - an unanticipated loss from disasters or
recognized. Only accountable events are recognized. other similar events.
2. Measuring - involves assigning numbers, normally in
monetary terms, to the economic transactions and Measuring - involves assigning numbers, normally in
events. monetary terms, to the economic transactions and events.
3. Communicating - the process of transforming
Historical Cost - most commonly used as measurement.
economic data into useful accounting information, such
as financial statements and other accounting reports, Mixture of cost and values - financial statements are said
for dissemination to users. to be prepared using a
Recognition - refers to the process of including the effects Opinion - When measurement is affected by estimates, the
of an accountable event in the balance sheet or income items measured are said to be valued by
statement through journal entry.
Fact - When measurement is unaffected by estimates, the
Accountable Event - is one that affects the assets, items measured are said to be valued by
liabilities, equity, income or expenses of an entity and also
known as economic activity. Basic purpose of accounting - is to provide information
about economic activities intended to be useful in making
Memorandum entry - A non-accountable event that has economic decisions.
an accounting relevance may be recorded through a
Communicating - is the process of transforming
Types of Events economic data into useful accounting information, such as
External Events - events that involve an entity and financial statements and other accounting reports, for
another external party. dissemination to users.
a. Exchange (reciprocal transfer) - an event
wherein there is a reciprocal giving and receiving Recording - refers to the process of systematically
of economic resources or discharging of economic committing into writing the identified and measured
obligations between an entity and an external accountable events in the journal through journal entries.
party. Classifying - involves the grouping of similar and
Ex. Sale, Purchase, Payment of Liabilities. interrelated items into their respective classes through
b. Non-reciprocal transfer - is a one way postings in the ledger.
transaction in that the party giving does not
receive anything in return, while the party Summarizing - putting together or expressing condensed
receiving does not give anything in exchange. from the recorded and classified transactions and events.
Ex. donations, gift, charity contri, fines. This includes preparation of financial statements and other
c. External events other than transfer - an event accounting reports.
that involves changes in the economic resources or
obligations of an entity caused by an external party or
external source but does not involve transfers of
resources or obligations.
Economic Entity - is a separately identifiable Special purpose accounting information - designed to
combination of persons and property that uses or controls meet the specific needs of particular statement users. This
economic resources to achieve certain goals or objectives. information is provided by other types of accounting, e.g.,
a. Not-for-profit entity - one that carries out some managerial accounting, tax basis accounting, etc.
socially desirable needs of the community or its
As social science - accounting is a body of knowledge
members and whose activities are not directed
which has been systematically gathered, classified and
towards making profit.
organized.
b. Business entity - one that operates primarily for
profit. As a practical art - accounting requires the use of
creative skills and judgment.
Production - the process of converting economic resource
into outputs of goods and services that are intended to Language of business - Accounting is often referred to as
have greater utility than the required inputs. a because it is fundamental to the communication of
financial information.
Exchange - the process of trading resources or obligations
for other resources or obligations. Creative thinking - involves the use of imagination and
insight to solve problems by finding new relationships
Consumption - the process of using the final output of the (ideas) among items of information. It is most important in
production process. identifying alternative solutions.
Income distribution - the process of allocating rights to Critical thinking - involves the logical analysis of issues,
the use of output among individuals and groups in society. using inductive or deductive reasoning to test new
relationships to determine their effectiveness. It is most
Savings - the process of setting aside rights to present
important in evaluating alternative solutions.
consumption in exchange for rights to future consumption.
Accounting concepts - refer to the principles upon which
Investment - the process of using current inputs to
the process of accounting is based and is used
increase the stock of resources available for output as
interchangeably.
opposed to immediately consumable output.
Accounting assumptions - are the fundamental concepts
Types of Information Provided by Accounting
or principles and basic notions that provide the foundation
Quantitative information - information expressed in
of the accounting process.
numbers, quantities, or units.
Accounting theory - is logical reasoning in the form of a
Qualitative information - information expressed in words
set of broad principles that provide a general frame of
or descriptive form. Qualitative information is found in the
reference by which accounting practice can be evaluated
notes to financial statements as well as on the face of the
and guide the development of new practices and
other financial statements.
procedures.
Financial information - information expressed in money.
Double-entry system – each accountable event is
• Financial information is also quantitative information
recorded in two parts– debit and credit.
because monetary amounts are normally expressed in
numbers. Going concern - the entity is assumed to carry on its
operations for an indefinite period of time. Meaning, the
Types of Accounting Information Classified as To entity does not expect to end its operations in the
Users’ Needs foreseeable future.
General purpose accounting information - designed to
meet the common needs of most statement users. This Separate entity – the entity is treated separately from its
information is governed by the Philippine Financial owners.
Reporting Standards (PFRSs).
Stable monetary unit - amounts in the financial Realization – the process of converting non-cash assets
statements are stated in terms of a common unit of into cash or claims for cash.
measure; changes in purchasing power are ignored.
Prudence (Conservatism) – the inclusion of a degree of
Time Period – the life of the business is divided into caution in the exercise of the judgments needed in making
series of reporting periods. the estimates required under conditions of uncertainty ,
such that assets or income are not overstated and liabilities
Calendar year - starts at Jan 1
or expenses are not understated.
Fiscal Year - can starts other than Jan 1
Common Branches of Accounting
Materiality concept – information is material if its
Financial accounting - focuses on general purpose
omission or misstatement could influence economic
financial statements.
decisions.
Management accounting – focuses on special purpose
Cost-benefit – the cost of processing and communicating
financial reports for use by an entity’s management.
information should not exceed the benefits to be derived
from it. Cost accounting - the systematic recording and analysis
of the costs of materials, labor, and overhead incident to
Accrual Basis of accounting – effects of transactions are
production.
recognized when they occur (and not as cash is received or
paid) and they are recognized in the accounting periods to Auditing - the process of evaluating the correspondence
which they relate. of certain assertions with established criteria and
expressing an opinion thereon.
Historical cost concept – the value of an asset is
determined on the basis of acquisition cost. Tax accounting - the preparation of tax returns and
rendering of tax advice, such as the determination of tax
Concept of Articulation – all of the components of a
consequences of certain proposed business endeavors.
complete set of financial statements are interrelated.
Government accounting - refers to the accounting for the
Full disclosure principle – financial statements provide
government and its instrumentalities, placing emphasis on
sufficient detail to disclose matters that make a difference
the custody of public funds, the purposes for which those
to users, yet sufficient condensation to make the
funds are committed, and the responsibility and
information understandable, keeping in mind the costs of
accountability of the individuals entrusted with those
preparing and using it.
funds.
Consistency concept – financial statements are prepared
Four sectors in the practice of accountancy
on the basis of accounting policies which are applied
consistently from one period to the next. Practice of Public Accountancy - involves the rendering
of audit or accounting related services to more than one
Matching – costs are recognized as expenses when the
client on a fee basis.
related revenue is recognized.
Practice in Commerce and Industry - refers to
Residual equity theory – this theory is applicable where
employment in the private sector in a position which
there are two classes of shares issued, ordinary and
involves decision making requiring professional
preferred.
knowledge in the science of accounting and such position
The equation is “Assets – Liabilities – Preferred requires that the holder thereof must be a CPA.
Shareholders’ Equity = Ordinary Shareholders’ Equity.”
Practice in Education/Academe – employment in an
Fund theory – the accounting objective is the custody and educational institution which involves teaching of
administration of funds. accounting, auditing, management advisory services,
finance, business law, taxation, and other technically
related subjects.
Practice in the Government – employment or Primary users – are those who cannot demand
appointment to a position in an accounting professional information directly from reporting entities.
group in the government or in a government–owned a. Existing and potential investors
and/or controlled corporation where decision making b. Lenders and other creditors.
requires professional knowledge in the science of
*Only the common needs of primary users are met by the
accounting, or where civil service eligibility as a CPA is a
financial statements.
prerequisite.
Financial Position - information on economic resources
Primary objective of financial reporting - to provide
(assets) and claims against the reporting entity (liabilities
information about an entity’s economic resources, claims
and equity)
to those resources, and changes in those resources.
Changes in Economic Resources and Claims -
Bookkeeping - refers to the process of recording the
information on financial performance (income and
accounts or transactions of an entity.
expenses)
Philippine Financial Reporting Standards (PFRSs) –
Liquidity - refers to an entity’s ability to pay short-term
are Standards and Interpretations adopted by the Financial
obligations.
Reporting Standards Council (FRSC).
Solvency - refers to an entity’s ability to meet its long-
CONCEPTUAL FRAMEWORK FOR FINANCIAL
term obligations.
REPORTING
Accrual Accounting - It provides a better basis for
General purpose financial reporting - The Conceptual
assessing an entity’s financial performance than
Framework prescribes the concepts for and is concerned
information based solely on cash receipts and payment
with.
during the period. fundamental qualitative characteristics -
Promote Transparency - by enhancing the international are the characteristics that make information useful to
comparability and quality of financial information. users.
Strengthen Accountability - by reducing the information a. Relevance - Information is relevant if it can affect the
gap between providers of capital and the entity’s decisions of users.
management. I. Predictive Value - the information can be used in
making predictions.
Contribute to Economic Efficiency - by helping
II. Confirmatory Value - the information can be
investors to identify opportunities and risks around the
used in confirming past predictions.
world, thus improving capital allocation.
III. Materiality - – is an ‘entity-specific’ aspect of
PFRS will prevail - The Conceptual Framework is not a relevance.
PFRS. When there is a conflict between the Conceptual b. Faithful Representation - means the information
Framework and a PFRS, the Conceptual Framework - In provides a true, correct and complete depiction of what
the absence of a standard, management shall consider the it purports to represent.
______ in making its judgment in developing and I. Completeness – all information necessary for
applying an accounting policy that results in useful users to understand the phenomenon being
information. depicted is provided.
II. Neutrality – information is selected or presented
Objective of general-purpose financial reporting - is to without bias. Supported by prudence.
provide financial information about the reporting entity III. Free from error – there are no errors in the
that is useful to primary users in making decisions about description and in the process by which the
providing resources to the entity. information is selected and applied. enhancing
Foundation - The objective of general purpose financial qualitative characteristics - are the characteristics
reporting forms the _______ of the Conceptual that enhance the usefulness of information.
Framework.
1. Comparability – the information helps users in Asset - is “a present economic resource controlled by the
identifying similarities and differences between entity as a result of past events. An economic resource is a
different sets of information. right that has the potential to produce economic benefits.”
2. Verifiability – different users could reach consensus 1. Right – asset refers to a right, and not necessarily to a
as to what the information purports to represent. physical object, e.g., the right to use, sell, lease or
3. Timeliness – the information is available to users in transfer a building.
time to be able to influence their decisions. 2. Potential to produce economic benefits – the right
4. Understandability - Information is understandable if has a potential to produce economic benefits for the
it is presented in a clear and concise manner. entity that are beyond the benefits available to all
a. reasonable knowledge of business activities; others.
b. willingness to analyze the information diligently. 3. Control – means the entity has the exclusive right
over the benefits of an asset and the ability to prevent
Cost - is a pervasive constraint on the entity's ability to others from accessing those benefits.
provide useful financial information.
Liability - is “a present obligation of the entity to transfer
Financial statements and the Reporting Entity an economic resource as a result of past events.”
1. Obligation – An obligation is “a duty or
The objective of general purpose financial statements
responsibility that an entity has no practical ability to
is
avoid.” can be legal or constructive
to provide financial information about the reporting
2. Transfer of an economic resource – the obligation
entity’s
has the potential to require the transfer of an
assets, liabilities, equity, income and expenses that is
economic resource to another party.
useful
3. Present obligation as a result of past events – A
in assessing:
present obligation exists as a result of past events if:
a. the entity’s ability to generate future net cash
a. the entity has already obtained economic benefits
inflows;
or taken an action;
b. management’s stewardship over economic
b. as a consequence, the entity will or may have to
resources.
transfer an
c. economic resource that it would not otherwise
Reporting Period - Financial statements are prepared for
have had to transfer.
a
specific period of time (i.e., the reporting period) and Executory Contracts - “is a contract that is equally
include comparative information for at least one unperformed – neither party has fulfilled any of its
preceding reporting period. obligations, or both parties have partially fulfilled their
obligations to an equal extent.”
Going Concern - Financial statements are normally
prepared on the assumption that the reporting entity is a An executory contract establishes a combined right and
going concern, meaning the entity has neither the intention obligation to exchange economic resources.
nor the need to end its operations in the foreseeable future.
Equity - “Equity is the residual interest in the assets of the
Reporting Entity - is one that is required, or chooses, to entity after deducting all its liabilities.”
prepare financial statements, and is not necessarily a legal E=A-L
entity. It can be a single entity or a group or combination
of two or more entities. Income - is “increases in assets, or decreases in liabilities
that result in increases in equity, other than those relating
to contributions from holders of equity claims.”
Expenses - are “decreases in assets, or increases in
liabilities, that result in decreases in equity, other than
those relating to distributions to holders of equity claims.”
Recognition - is the process of including in the statement Current Value - measures reflect changes in values at the
of financial position or the statement(s) of financial measurement date. It is not derived from the price of the
performance an item that meets the definition of one of the transaction or other event that gave rise to the asset or
financial statement elements (i.e., asset, liability, equity, liability.
income or expense). This involves recording the item in
words and in monetary amount and including that amount a. Fair Value - is “the price that would be received to sell
in the totals of either of those statements. an asset, or paid to transfer a liability, in an orderly
transaction between market participants at the
An item is recognized if: measurement date.”
a. it meets the definition of an asset, liability, equity,
income or expense; b. Value in use - is “the present value of the cash flows,
b. recognizing it would provide useful information, i.e., or other economic benefits, that an entity expects to derive
relevant and faithfully represented information. from the use of an asset and from its ultimate disposal.”

Relevance c. Fulfilment Value - is “the present value of the cash, or

The recognition of an item may not provide relevant other economic resources, that an entity expects to be
information if, for example: obliged to transfer as it fulfils a liability.”
a. it is uncertain whether an asset or liability exists; d. Current Cost
b. an asset or liability exists, but the probability of an I. an asset is “the cost of an equivalent asset at the
inflow or outflow of economic benefits is low. measurement date, comprising the consideration
Faithful Representation that would be paid at the measurement date plus
the transaction costs that would be incurred at that
• The level of measurement uncertainty and other date.”
factors can affect an item’s faithful representation, II. a liability is “the consideration that would be
but not necessarily its relevance. received for an equivalent liability at the
measurement date minus the transaction costs that
Measurement Uncertainty - exists if the asset or liability would be incurred at that date.”
needs to be estimated.
Entry Values - Current cost and historical cost are (i.e.,
Derecognition - is the removal of a previously recognized they reflect prices in acquiring an asset or incurring a
asset or liability from the entity’s statement of financial liability),
position. occurs when the item ceases to meet the
definition of an asset or liability. Exit Values - fair value, value in use and fulfilment value
are (i.e., they reflect prices in selling or using an asset or
Unit of Account - is “the right or the group of rights, the transferring or fulfilling a liability). presentation and
obligation or the group of obligations, or the group of disclosure - Information is communicated through _____
rights and obligations, to which recognition criteria and in the financial statements.
measurement concepts are applied.”
Effective communication makes information more:
Measurement Bases
a. focusing on presentation and disclosure objectives
Historical Cost and principles rather than on rules.
a. an asset is the consideration paid to acquire the asset b. classifying information by grouping similar items and
plus transaction costs. separating dissimilar items.
b. a liability is the consideration received to incur the c. aggregating information in a manner that it is not
liability minus transaction costs. obscured either by excessive detail or by excessive
Historical cost is updated over time to depict the summarization.
following: Standards - The objectives are specified.
a. Depreciation, amortization, or impairment of assets The principles include:
b. Collections or payments that extinguish part or all of
the asset or liability. a. the use of entity-specific information is more useful
that standardized descriptions,
b. duplication of information is usually unnecessary.
Classification/Classifying - means combining similar - are the subject matter of the Conceptual Framework
items and separating dissimilar items. and the PFRSs.
• Offsetting of assets and liabilities is generally not
appropriate. PURPOSE OF FINANCIAL STATEMENTS
Primary Objective - To provide information about the
Income and expenses are classified as recognized either in:
financial position, financial performance, and cash flows
a. profit or loss; of an entity that is useful to a wide range of users in
b. other comprehensive income. making economic decisions.
Offsetting - occurs when an asset and a liability with Secondary Objective - To show the results of
separate units of account are combines and only the net management’s stewardship over the entity’s resources.
amount is presented in the statement of financial position.
Complete set of financial statements
Aggregation - is “the adding together of assets, liabilities, 1. Statement of financial position
equity, income or expenses that have shared characteristics 2. Statement of profit or loss and other comprehensive
and are included in the same classification.” income
3. Statement of changes in equity
Financial concept of capital – capital is regarded as the 4. Statement of cash flows
invested money or invested purchasing power. Capital is 5. Notes
synonymous with equity, net assets, and net worth. a. comparative information in respect of the
Physical concept of capital – capital is regarded as the preceding period;
entity’s productive capacity, e.g., units of output per day. 6. Additional statement of financial position (required only
when certain instances occur)
PAS 1: PRESENTATION OF FINANCIAL General features
STATEMENTS
1. Fair Presentation and Compliance with PFRSs -The
PAS 1 - prescribes the basis for presentation of general application of PFRSs, with additional disclosure when
purpose financial statements to improve comparability necessary, is presumed to result in financial statements
both with the entity's financial statements of previous that achieve a fair presentation.
periods (intra-comparability) and with the financial
statements of other entities (inter-comparability). 2. Going Concern - An entity is not a going concern if, as
of the financial reporting date or prior to the date of
TYPES OF COMPARABILITY authorization of the financial statements for issue,
management either:
Intra-comparability (horizontal or inter-period) – a. Intends to liquidate the entity or to cease trading,
refers to the comparability of financial statements of the b. Has no realistic alternative but to do so.
same entity but from one period to another. c. The assessment of going concern is at least 12
Inter-comparability (dimensional) - refers to the months.
comparability of financial statements between different 3. Accrual Basis of Accounting - An entity shall prepare
entities. its financial statements, except for cash flow information,
*PAS 1 applies to preparation and presentation of using the
general purpose financial statements 4. Materiality & Aggregation - Each material class of
Financial Statements - are the structured presentations of similar items must be presented separately in the financial
an entity’s financial position and results of its operations. statements.

General purpose financial statements - are those

intended to serve users who do not have the authority to
demand financial reports tailored for their own needs.
- cater to most of the common needs of a wide range
of external users.
5. Offsetting - Assets and liabilities, and income and 2. Unclassified (based on liquidity) – showing no
expenses, shall not be offset unless required or distinction between current and noncurrent items
permitted by a PFRS.
a. Measuring assets net of valuation allowances, for * PAS 1 encourages the classified presentation
example, obsolescence allowances on inventories, Current Asset - for trading, 12 months after the reporting
allowances for doubtful accounts on receivables, and date, unrestricted cash.
accumulated depreciation on property, plant, and
equipment are not offsetting. Current Liabilities - same with current asset
6. Frequency of reporting – An entity shall present a General Rule
complete set of financial statements (including Current Liabilities - Currently maturing long term
comparative information) at least annually. liabilities are presented as
7. Comparative Information - An entity shall present Exception: The entity has the right, at the end of the
comparative information in respect of the preceding period reporting period, to roll over the obligation for at least
for all amounts reported in the current period’s financial twelve months after the reporting period under an existing
statements, unless other standards permit or require loan facility – non-current liability
otherwise.
Current liability - A liability that is payable on demand
8. Consistency of presentation - An entity shall retain the
Exception: It is presented as non-current liability if the
presentation and classification of items in the financial
lender provides the entity, on or before the balance sheet
statements from one period to the next unless:
date, a grace period ending at least 12 months after the
a. it is apparent that another presentation or
balance sheet date to rectify a breach of loan covenant.
classification would be more appropriate following a
significant change in the nature of the entity’s Non-current items - Deferred tax liabilities (assets) are
operations or a review of its financial statements. presented as _______ in a classified statement of financial
b. a PFRS requires a change in presentation. position, irrespective of their expected dates of reversal.
An additional statement of financial position is presented * PAS 1 does not prescribe the order or format in
as at the beginning of the preceding period when an entity: which an entity presents items.
1. Applies an accounting policy retrospectively,
2. Makes a retrospective restatement of items in its * PAS 1 prohibits the presentation of any items of
financial statements, income or expense as extraordinary items in the
3. reclassifies items in its financial statements. statement(s) presenting profit or loss and other
comprehensive income or in the notes.
…..and the effect of the event to the statement of financial
position as at the beginning of the preceding period is Income and Expenses may be presented:
material. a. Single statement of profit or loss and other
comprehensive income
Management - responsible for an entity’s financial b. Two statements - an income statement and statement
statements. of presenting comprehensive income.
a. the preparation and fair presentation of financial
statements in accordance with PFRS
b. internal control over financial reporting
Statement of financial position - shows the entity’s
financial condition (status of assets, liabilities, and equity_
as at a certain date.
A statement of financial position may be presented as
either:
Profit or Loss - is income less expenses, excluding the
1. Classified – showing distinctions between current and
components of other comprehensive income.
noncurrent assets and liabilities,
Reclassification adjustments - are amounts reclassified * PAS 1 allows Dividends declared by an entity are
to profit or loss in the current period that were recognized disclosed either in the (a) notes or (b) statement of
in other comprehensive income in the current or previous changes in equity.
periods.
* Non-owner changes in equity are presented in the
- Are amounts reclassified from OCI to profit or loss. statement of comprehensive income while the owner
changes (contributions and distributions to owner) are
presented in the statement of changes in equity.
Notes - provides information in addition to those
presented in the other financial statement. It is an integral
part of a complete set of financial statements.

Other Comprehensive Income - comprises items of

income and expense (including reclassification
adjustments) that are not recognized in profit or loss as
required or permitted by other PFRS.
* OCI may be presented either (a) net of tax or (b)
gross of tax.
Total comprehensive income - is the change in equity
during a period resulting from transactions and other
events, other than those changes resulting from
transactions with owners in their capacity as owners.
(TCI= Profit orLoss + OCI)
Total comprehensive income comprises all components of
1. Profit or loss; and
2. Other comprehensive income.
* Total comprehensive income includes all non-owner
changes in equity.
PRESENTATION OF EXPENSES
Nature of Expense Method - Under this method,
expenses are aggregated according to their nature.
(depreciation, purchase of materials, transportation cost)
and are not reallocated according to their functions within
the entity.
Function of Expense Method (Cost of Sales Method) -
Under this method, an entity classifies expenses according
to their function (cost of sales, cost, expenses) at a
minimum cost of sales shall be presented separately from
other expenses,
* Additional disclosure is required when the function
of expense method is used.