UNIT II

CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING

(2018 VERSION)

INTRODUCTION
The International Accounting Standards Board (Board) issued the revised Conceptual
Framework for Financial Reporting (Conceptual Framework), a comprehensive set of
concepts for financial reporting, in March 2018. It sets out, the objective of financial
reporting; the qualitative characteristics of useful financial information; a description of
the reporting entity and its boundary; definitions of an asset, a liability, equity, income
and expenses; criteria for including assets and liabilities in financial statements
(recognition) and guidance on when to remove them (derecognition); measurement
bases and guidance on when to use them; and concepts and guidance on presentation
and disclosure.

LEARNING OBJECTIVES
After reading this unit, you should be able to:
1. State the purpose and status of the conceptual framework for financial reporting.
2. Explain the objective of the general-purpose financial reporting and the
information needs of its users.
3. Enumerate the qualitative characteristics of useful financial information and
illustrate their application.
4. Explain what a reporting entity is.
5. Illustrate the application of the going concern assumption and accrual basis of
accounting.
6. Define the elements of the financial statements and explain the criteria for their
recognition and the bases for their measurement.
7. Discuss the concepts applied for derecognition of assets and liabilities.
8. Explain how an entity can effectively communicate its financial information
through financial statement presentation and disclosure.
9. Discuss the two concepts of capital and the two concepts of capital maintenance.

LECTURE DISCUSSION

STATUS AND PURPOSE OF THE CONCEPTUAL FRAMEWORK

The Conceptual Framework for Financial Reporting (Conceptual Framework) describes
the objective of, and the concepts for, general purpose financial reporting. The purpose
of the Conceptual Framework is to:
a. Assist the International Accounting Standards Board (Board) to develop IFRS
Standards (Standards) that are based on consistent concepts;
b. assist preparers to develop consistent accounting policies when no Standard

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 applies to a particular transaction or other event, or when a Standard allows a
choice of accounting policy; and
c. assist all parties to understand and interpret the Standards.

The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework

overrides any Standard or any requirement in a Standard. To meet the objective of
general- purpose financial reporting, the Board may sometimes specify requirements
that depart from aspects of the Conceptual Framework. If the Board does so, it will
explain the departure in the Basis for Conclusions on that Standard.

OBJECTIVE, USEFULNESS AND LIMITATIONS OF GENERAL-PURPOSE

FINANCIAL REPORTING
The objective of general-purpose financial reporting forms the foundation of the
Conceptual Framework. Other aspects of the Conceptual Framework—the qualitative
characteristics of, and the cost constraint on, useful financial information, a reporting
entity concept, elements of financial statements, recognition and derecognition,
measurement, presentation and disclosure—flow logically from the objective.

The objective of general-purpose financial reporting is to provide financial information

about the reporting entity that is useful to existing and potential investors, lenders and
other creditors in making decisions relating to providing resources to the entity. Those
decisions involve decisions about:
a. buying, selling or holding equity and debt instruments;
b. providing or settling loans and other forms of credit; or
c. exercising rights to vote on, or otherwise influence, management’s actions that
affect the use of the entity’s economic resources.

The decisions described depend on the returns that existing and potential investors,
lenders and other creditors expect, for example, dividends, principal and interest
payments or market price increases. Investors’, lenders’ and other creditors’
expectations about returns depend on their assessment of the amount, timing and
uncertainty of (the prospects for) future net cash inflows to the entity and on their
assessment of management’s stewardship of the entity’s economic resources. Existing
and potential investors, lenders and other creditors need information to help them make
those assessments. To make the assessments described, existing and potential
investors, lenders and other creditors need information about:
a. the economic resources of the entity, claims against the entity and changes in
those resources and claims; and
b. how efficiently and effectively the entity’s management and governing board have
discharged their responsibilities to use the entity’s economic resources.

Many existing and potential investors, lenders and other creditors cannot require
reporting entities to provide information directly to them and must rely on general
purpose financial reports for much of the financial information they need.
Consequently,theyaretheprimaryuserstowhomgeneral purpose financial reports are
directed. To a large extent, financial reports are based on estimates, judgements and

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models rather than exact depictions. The Conceptual Framework establishes the
concepts that underlie those estimates, judgements and models. The concepts
arethegoaltowardswhichtheBoardandpreparersoffinancialreportsstrive.Aswithmostgoals,
theConceptualFramework’svisionofidealfinancialreportingisunlikelytobeachievedinfull,at
leastnotintheshortterm,becauseittakestimetounderstand,acceptandimplementnewways
of analyzing transactions and other events. Nevertheless, establishing a goal towards
which to strive is essential if financial reporting is to evolve to improve its usefulness.

ECONOMICRESOURCESANDCLAIMS
Informationaboutthenatureandamountsofareportingentity’seconomicresourcesand
claims can help users to identify the reporting entity’s financial strengths and
weaknesses. That information can help users to assess the reporting entity’s liquidity
and solvency, its needs for additional financing and how successful it is likely to be in
obtaining that financing. That information can also help users to assess management’s
stewardship of the entity’s economic resources. Information about priorities and
payment requirements of existing claims helps users
topredicthowfuturecashflowswillbedistributedamongthosewithaclaimagainstthereporting
entity.

CHANGESINECONOMICRESOURCESANDCLAIMS
Changes in a reporting entity’s economic resources and claims result from that entity’s
financial performance and from other events or transactions such as issuing debt or
equity instruments. To properly assess both the prospects for future net cash inflows to
the reporting entity andmanagement’s stewardship ofthe entity’s economic resources,
users needto be able to identify those two types of changes.

FINANCIALPERFORMANCEREFLECTEDBYACCRUALACCOUNTING
Accrualaccountingdepictstheeffectsoftransactionsandothereventsandcircumstances
onareportingentity’seconomicresourcesandclaimsintheperiodsinwhichthoseeffectsoccur,
even if the resulting cash receipts and payments occur in a different period. This is
important
becauseinformationaboutareportingentity’seconomicresourcesandclaimsandchangesinit
s
economicresourcesandclaimsduringaperiodprovidesabetterbasisforassessingtheentity’s
past and future performance than information solely about cash receipts and payments
during that period.

QUALITATIVECHARACTERISTICSOFUSEFULFINANCIALINFORMATION
The qualitative characteristics of useful financial information discussed in this chapter
identify the types of information that are likely to be most useful to the existing and
potential
investors,lendersandothercreditorsformakingdecisionsaboutthereportingentityonthebasis
of information in its financial report (financial information). Financial reports provide
information
aboutthereportingentity’seconomicresources,claimsagainstthereportingentityandtheeffec
ts of transactions and other events and conditions that change those resources and

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claims. (This information is referred to in the Conceptual Framework as information
about the economic phenomena.) Some financial reports also include explanatory
material about management’s
expectationsandstrategiesforthereportingentity,andothertypesofforward-
lookinginformation. If financialinformation isto beuseful, it must berelevant
andfaithfullyrepresentwhat it purports to represent. The usefulness of financial
information is enhanced if it is comparable, verifiable, timely and understandable.

FUNDAMENTALQUALITATIVECHARACTERISTICS

RELEVANCE
Relevant financial information can make a difference in the decisions made by users.
Information may be capable of making a difference in a decision even if some users
choose not to take advantage of it or are already aware of it from other sources.
Financial information can make a difference in decisions if it has predictive value,
confirmatory value or both.

FAITHFULREPRESENTATION
Financial reports represent economic phenomena in words and numbers. To be useful,
financial information must not only represent relevant phenomena, but it must also
faithfully represent thesubstanceof the phenomenathat itpurportstorepresent. Inmany
circumstances, the substance of an economic phenomenon and its legal form are the
same. If they are not the
same,providinginformationonlyaboutthelegalformwouldnotfaithfullyrepresenttheeconomi
c phenomenon. To be a perfectly faithful representation, a depiction would have three
characteristics.Itwouldbecomplete,neutralandfreefromerror.Ofcourse,perfectionisseldom
, if ever, achievable. The Board’s objective is to maximize those qualities to the extent
possible.

ENHANCINGQUALITATIVECHARACTERISTICS
Comparability,verifiability,timelinessandunderstandabilityarequalitativecharacteristics
that enhance the usefulness of information that both is relevant and provides a faithful
representationofwhatitpurportstorepresent.Theenhancingqualitativecharacteristicsmayal
so
helpdeterminewhichoftwowaysshouldbeusedtodepictaphenomenonifbothareconsidered
toprovideequallyrelevantinformationandanequallyfaithfulrepresentationofthatphenomeno
n.

COMPARABILITY
Users’decisionsinvolvechoosingbetweenalternatives,forexample,sellingorholdingan
investment, or investing in one reporting entity or another. Consequently, information
about a reporting entity is more useful if it can be compared with similar information
about other entities and with similar information about the same entity for another period
or another date. Comparability is the qualitative characteristic that enables users to
identify and understand similarities in, and differences among, items. Unlike the other

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qualitative characteristics, comparability does not relate to a single item. A comparison
requires at least two items.

VERIFIABILITY
Verifiability helps assure users that information faithfully represents the economic
phenomena it purports to represent. Verifiability means that different knowledgeable
and independent observers could reach consensus, although not necessarily complete
agreement, that a depiction is a faithful representation. Quantified information need not
be a single point estimate to be verifiable. A range of possible amounts and the related
probabilities can also be verified.

TIMELINESS
Timeliness means having information available to decision-makers in time to be capable
ofinfluencingtheirdecisions.Generally,theoldertheinformationisthelessusefulitis.However,
some informationmaycontinue tobetimely longafterthe end of areporting period
because,for example, some users may need to identify and assess trends.

UNDERSTANDABILITY
Classifying, characterizing and presenting information clearly and concisely makes it
understandable. Financial reports are prepared for users who have a reasonable
knowledge of
businessandeconomicactivitiesandwhoreviewandanalyzetheinformationdiligently.Attime
s, even well-informed and diligent users may need to seek the aid of an adviser to
understand information about complex economic phenomena.

THECOSTCONSTRAINTONUSEFULFINANCIALREPORTING
Cost is a pervasive constraint on the information that can be provided by financial
reporting. Reporting financial information imposes costs, and it is important that those
costs are
justifiedbythebenefitsofreportingthatinformation.Thereareseveraltypesofcostsandbenefit
s to consider.

FINANCIALSTATEMENTS
Financialstatementsprovideinformationabouteconomicresourcesofthereportingentity,
claimsagainsttheentity,andchangesinthoseresourcesandclaims,thatmeetthedefinitionsof
the elements of financialstatements. The objective offinancial statementsis to provide
financial information about the reporting entity’s assets, liabilities, equity, income and
expenses that is useful to users of financial statements in assessing the prospects for
future net cash inflows to the reporting entity and in assessing management’s
stewardship of the entity’s economic resource. That information is provided:

a. inthestatementoffinancialposition,byrecognizingassets,liabilitiesandequity;
b. inthestatement(s)offinancialperformance,byrecognizingincomeand expenses; and
c. inotherstatementsandnotes,bypresentinganddisclosinginformationabout:
i. recognizedassets,liabilities,equity,incomeandexpenses,includinginformatio
n about their nature and about the risks arising from those recognized

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 assets and liabilities;
ii. assets and liabilities that have not been recognized, including information
about their nature and about the risks arising from them;
iii. cashflows;
iv. contributionsfromholdersofequityclaimsanddistributionstothem;and
v. the methods, assumptions and judgements used in estimating the
amounts presented or disclosed, and changes in those methods,
assumptions and judgements.

REPORTINGPERIOD
Financial statements are prepared for a specified period of time (reporting period)
andprovide information about:
a. assets and liabilities—including unrecognized assets and liabilities—and equity
that existed at the end of the reporting period, or during the reporting period; and
b. incomeandexpensesforthereportingperiod.

Tohelp users offinancialstatementsto identify andassess changes and trends,financial

statements also provide comparative information for at least one preceding reporting
period.

GOINGCONCERNASSUMPTION
Financialstatementsarenormally preparedonthe assumptionthat thereportingentityis a
going concern and will continue in operation for the foreseeable future. Hence, it is
assumed
thattheentityhasneithertheintentionnortheneedtoenterliquidationortoceasetrading.Ifsuch
anintentionorneedexists,thefinancialstatementsmayhavetobepreparedonadifferentbasis.
If so, the financial statements describe the basis used.

THEELEMENTSOFFINANCIALSTATEMENTS

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Anassetisapresenteconomicresourcecontrolledbytheentityasaresultofpastevents.
Aneconomicresourceisarightthathasthepotentialtoproduceeconomicbenefits.Thissection
discusses three aspects of those definitions:
a. right;
b. potentialtoproduceeconomicbenefits;and
c. control.

Aliabilityisapresentobligationoftheentitytotransfer aneconomicresourceasaresult of past

events. For a liability to exist, three criteria must all be satisfied:
a. theentityhasanobligation;
b. theobligationistotransferaneconomicresource;and
c. theobligationisapresentobligationthatexistsasaresultofpastevents.

Equity is the residual interest in the assets of the entity after deducting all its liabilities.
Equity claims are claims on the residual interest in the assets of the entity after
deducting all its liabilities. In other words, they are claims against the entity that do not
meet the definition of a
liability.Suchclaimsmaybeestablishedbycontract,legislationorsimilarmeans,andinclude,to
the extent that they do not meet the definition of a liability:
a. sharesofvarioustypes,issuedbytheentity;and
b. someobligationsoftheentitytoissueanotherequityclaim.

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Incomeisincreasesinassets,ordecreasesinliabilities,thatresultinincreasesinequity, 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.

Income and expenses are the elements of financial statements that relate to an entity’s
financial performance. Users of financial statements need information about both an
entity’s financial position and its financial performance. Hence, although income and
expenses are defined in terms of changes in assets and liabilities, information about
income and expenses is just as important as information about assets and liabilities.

THERECOGNITIONPROCESS
Recognition is the process of capturing for inclusion in the statement offinancial position
or the statement(s) of financial performance an item that meets the definition of one of
the elements of financial statements—an asset, a liability, equity, income or expenses.
Recognition involves depictingtheitem in one ofthose statements—either alone or
inaggregationwith other items—in words and by a monetary amount and including that
amount in one or more totals in that statement. The amount at which an asset, a liability
or equity is recognized in the statement of financial position is referred to as its ‘carrying
amount’.

The statement of financial position and statement(s) of financial performance depict an

entity’s recognized assets, liabilities, equity, income and expenses in structured
summaries that
aredesignedtomakefinancialinformationcomparableandunderstandable.Animportantfeat
ure of thestructures of thosesummaries isthat the amounts recognizedin astatement
areincluded in the totals and, if applicable, subtotals that link the items recognized in the
statement.

Recognitionlinkstheelements;thestatementoffinancialpositionandthestatement(s)of
financial performance as follows:
a. inthestatementoffinancialpositionatthebeginningandendofthereportingperiod, total
assets minus total liabilities equal total equity; and
b. recognizedchangesinequityduringthereportingperiodcomprise:
i. income minus expenses recognized in the statement(s) of financial
performance; plus
ii. contributions from holders of equity claims, minus distributions to holders
of equity claims.

Thestatementsarelinkedbecausetherecognitionofoneitem(orachangeinitscarrying
amount) requires the recognition or derecognition of one or more other items (or
changes in the carrying amount of one or more other items). For example:
a. therecognitionofincomeoccursatthesametimeas:
i. the initial recognition of an asset, or an increase in the carrying

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 amount of an asset; or
ii. thederecognitionofaliability,oradecreaseinthecarryingamountofaliabili
ty.

b. therecognitionofexpensesoccursatthesametimeas:
i. the initial recognition of a liability, or an increase in the carrying
amount of aliability; or
ii. thederecognitionofanasset,oradecreaseinthecarryingamountofanass
et.

Recognitioncriteria
Only items that meet the definition of an asset, a liability or equity are recognized in the
statementoffinancialposition.Similarly,onlyitemsthatmeetthedefinitionofincomeorexpense
s
arerecognizedinthestatement(s)offinancialperformance.However,notallitemsthatmeetthe
definition of one of those elements are recognized. Not recognizing an item that meets
the definition of one of the elements makes the statement of financial position and the
statement(s) of financial performance less complete and can exclude useful information
from financial statements. On the other hand, in some circumstances, recognizing some
items that meet the definition of one of the elements would not provide useful
information. An asset or liability is recognized only if recognition of that asset or liability
and of any resulting income, expenses or changes in equity provides users of financial
statements with information that is useful.

DERECOGNITION
Derecognitionistheremovalofallorpartofarecognizedassetorliabilityfromanentity’s
statementoffinancialposition.Derecognitionnormallyoccurswhenthatitemnolongermeetsth
e definition of an asset or of a liability:
a. for an asset, derecognition normally occurs when the entity loses control of all or
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 part of the recognized asset; and
b. for a liability, derecognition normally occurs when the entity no longer has a
present obligation for all or part of the recognized liability.

MEASUREMENTBASES
Elements recognized in financial statements are quantified in monetary terms. This
requirestheselectionofameasurementbasis.Ameasurementbasisisanidentifiedfeature—
for example, historical cost, fair value or fulfilment value—of an item being measured.
Applying a measurement basis to an asset or liability creates a measure for that asset
or liability and for related income and expenses.

HISTORICALCOST
Historicalcostmeasuresprovidemonetaryinformationaboutassets,liabilitiesandrelated
incomeandexpenses,usinginformationderived,atleastinpart,fromthepriceofthetransaction
orothereventthatgaverisetothem.Unlikecurrentvalue,historicalcostdoesnotreflectchanges
in values, except to the extent that those changes relate to impairment of an asset or a
liability becoming onerous.

CURRENTVALUE
Currentvaluemeasuresprovidemonetaryinformationaboutassets,liabilitiesandrelated
income and expenses, usinginformationupdatedto reflect conditions atthemeasurement
date. Because of the updating, current values of assets and liabilities reflect changes,
since the
previousmeasurementdate,inestimatesofcashflowsandotherfactorsreflectedinthosecurre
nt values. Unlikehistoricalcost,thecurrent valueofanassetorliabilityisnot
derived,eveninpart,
fromthepriceofthetransactionorothereventthatgaverisetotheassetorliability.Currentvalue
measurement bases include:
a. fairvalue;
b. valueinuseandfulfilmentvalueforliabilities;and
c. currentcost

MEASUREMENTOFEQUITY
The total carrying amount of equity (total equity) is not measured directly. It equals the
total of thecarrying amounts of allrecognized assets lessthetotalof thecarrying amounts
of all recognized liabilities.

PRESENTATIONANDDISCLOSUREASCOMMUNICATIONTOOLS
A reporting entity communicates information about its assets, liabilities, equity, income
and expenses by presenting and disclosing information in its financial statements.
Effective communication of information in financial statements makes that information
more relevant and contributes to a faithful representation of an entity’s assets, liabilities,
equity, income and expenses. It also enhances the understandability and comparability
of information in financial statements.Just as cost constrains other financial reporting
decisions, it also constrains
decisionsaboutpresentationanddisclosure.Hence,inmakingdecisionsaboutpresentationa

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nd disclosure, it is important to consider whether the benefits provided to users of
financial statements by presenting or disclosing particular information are likely to justify
the costs of providing and using that information.

CLASSIFICATION
Classification is the sorting of assets, liabilities, equity, income or expenses based on
shared characteristics for presentation and disclosure purposes. Such characteristics
include— but are not limited to—the nature of the item, its role (or function) within the
business activities conducted by the entity, and how it is measured.

CLASSIFICATIONOFASSETSANDLIABILITIES
Classificationisappliedtotheunitofaccountselectedforanassetorliability.However,it
maysometimesbeappropriatetoseparateanassetorliabilityintocomponentsthathavediffere
nt characteristics and to classify those components separately. That would be
appropriate when classifyingthosecomponentsseparatelywould
enhancetheusefulnessoftheresultingfinancial
information.Forexample,itcouldbeappropriatetoseparateanassetorliabilityintocurrentand
non-current components and to classify those components separately.

OFFSETTING
Offsetting occurs when an entity recognizes and measures both an asset and liability as
separate units ofaccount, but groups them into asingle net amount in thestatement
offinancial
position.Offsettingclassifiesdissimilaritemstogetherandthereforeisgenerallynotappropriat
e.

CLASSIFICATIONOFEQUITY
To provide useful information, it may be necessary to classify equity claims separately if
those equity claims have different characteristics

CLASSIFICATIONOFINCOMEANDEXPENSES
Classificationisappliedto:
a. incomeandexpensesresultingfromtheunitofaccountselectedforanassetorliability; or
b. components of such income and expenses if those components have different
characteristicsandareidentifiedseparately.Forexample,achangeinthecurrentvalue
ofanassetcanincludetheeffectsofvaluechangesandtheaccrualofinterest.Itwould be
appropriate to classify those components separately if doing so would enhance
the usefulness of the resulting financial information.

PROFITORLOSSANDOTHERCOMPREHENSIVEINCOME
Incomeandexpensesareclassifiedandincludedeither:
a. inthestatementofprofitorloss;or
b. outsidethestatementofprofitorloss,inothercomprehensiveincome.

The statement of profit or loss is the primary source of information about an entity’s
financial performance for the reporting period. That statement contains a total for profit

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or loss that provides a highly summarized depiction of the entity’s financial performance
for the period.
Manyusersoffinancialstatementsincorporatethattotalintheiranalysiseitherasastartingpoint
for that analysis or as the main indicator of the entity’s financial performance for the
period.
Nevertheless,understandinganentity’sfinancialperformancefortheperiodrequiresananalys
is of all recognized income and expenses—including income and expenses included in
other comprehensive income—as well as an analysis of other information included in
the financial statements.

AGGREGATION
Aggregation is the adding together of assets, liabilities, equity, income or expenses that
have shared characteristics and are included in the same classification. Aggregation
makes
informationmoreusefulbysummarizingalargevolumeofdetail.However,aggregationconcea
ls some of that detail. Hence, a balance needs to be found so that relevant information
is not obscured either by a large amount of insignificant detail or by excessive
aggregation.

CONCEPTSOFCAPITAL
A financial concept of capital is adopted by most entities in preparing their financial
statements.Underafinancialconceptofcapital,suchasinvestedmoneyorinvestedpurchasin
g
power,capitalissynonymouswiththenetassetsorequityoftheentity.Underaphysicalconcept
ofcapital,suchasoperatingcapability,capitalisregardedastheproductivecapacityoftheentity
based on, for example, units of output per day.

CONCEPTSOFCAPITALMAINTENANCEANDTHEDETERMINATIONOFPROFIT
The concepts of capital give rise to the following concepts of capital maintenance:

a. Financialcapitalmaintenance.Underthisconceptaprofitisearnedonlyifthefinancial
(or money) amount of the net assets at the end of the period exceedsthefinancial
(or money) amount of net assets at the beginning of the period, after excluding
any distributions to, and contributions from, owners during the period. Financial
capital maintenance can be measured in either nominal monetary units or units
of constant purchasing power.
b. Physicalcapitalmaintenance. Underthisconceptaprofitisearnedonlyifthephysical
productive capacity (or operating capability) of the entity (or the resources or
funds needed to achieve that capacity) at the end of the period exceeds the
physical productivecapacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

The concept of capital maintenance is concerned with how an entity defines the capital
thatitseekstomaintain.Itprovidesthelinkagebetweentheconceptsofcapitalandtheconcepts
ofprofitbecauseitprovidesthepointofreferencebywhichprofitismeasured;itisaprerequisite
for distinguishing between an entity’s return on capital and its return of capital; only

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inflows of assetsin excessofamounts neededtomaintaincapitalmay beregardedas profit
andtherefore
asareturnoncapital.Hence,profitistheresidualamountthatremainsafterexpenses(including
capital maintenance adjustments, where appropriate) have been deducted from income.
If expenses exceed income the residual amount is a loss.

The physicalcapitalmaintenance conceptrequires theadoptionofthecurrent cost basis of

measurement. The financial capital maintenance concept, however, does not require
the use
ofabasisofmeasurement.Selectionofthebasisunderthisconceptisdependentonthetypeof
financial capital that the entity is seeking to maintain.

Under the concept of financial capital maintenance where capital is defined in terms of
nominal monetary units, profit representsthe increase in nominal moneycapitalover
theperiod.
Thus,increasesinthepricesofassetsheldovertheperiod,conventionallyreferredtoasholding
gains, are, conceptually, profits. They may not be recognized as such, however, until
the assets are disposed of in an exchange transaction. When the concept of financial
capital maintenance is defined intermsof
constantpurchasingpowerunits,profitrepresentsthe increasein invested
purchasingpowerovertheperiod.Thus,onlythatpartoftheincreaseinthepricesofassetsthat
exceedsthe increase inthe generallevel of pricesis regarded as profit. The rest of the
increase is treated as a capital maintenance adjustment and, hence, as part of equity.

Undertheconceptofphysicalcapitalmaintenancewhencapitalisdefinedintermsofthe
physicalproductivecapacity,profitrepresentstheincreaseinthatcapitalovertheperiod.Allpric
e changes affecting the assets and liabilities of the entity are viewed as changes in the
measurement of thephysicalproductivecapacityofthe entity; hence,
theyaretreatedascapital maintenance adjustments that are part of equity and not as
profit.

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 UNIT III

PRESENTATION OF FINANCIAL STATEMENTS (IAS 1 AND IAS 7)

INTRODUCTION
Financial statements are a structured representation of the financial position and
financial performance of an entity. General purpose financial statements (referred to as
‘financial statements’) are those intended to meet the needs of users who are not in a
position to require an entity to prepare reports tailored to their particular information
needs.

IAS 1 sets out overall requirements for the presentation of financial statements,
guidelines for their structure and minimum requirements for their content. It requires an
entity to present a complete set of financial statements at least annually, with
comparative amounts for the preceding year (including comparative amounts in the
notes).

LEARNING OBJECTIVES
After reading this unit, you should be able to:
1. Describe the objective of the financial statements.
2. Enumerate the components of financial statements and their respective uses.
3. Describe the hierarchy in the formation of accounting policies by the
management.
4. State and apply the general features in the presentation of the financial
statements.
5. Explain the limitations of the financial statements.
6. Classify the entities based on applicability of financial reporting frameworks.
7. Identify the different Philippine Financial Reporting frameworks and their
applicability.

LECTURE DISCUSSION

OBJECTIVE OF THE FINANCIAL STATEMENTS

The objective of financial statements is to provide information about the financial
position, financial performance and cash flows of an entity that is useful to a wide range
of users in making economic decisions. Financial statements also show the results of the
management’s stewardship of the resources entrusted to it.

To meet this objective, financial statements provide information about an entity’s:

 assets;
 liabilities;
 equity;

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  income and expenses, including gains and losses;
 contributions by and distributions to owners in their capacity as owners; and
 cash flows.

That information, along with other information in the notes, assists users of financial
statements in predicting the entity's future cash flows and their timing and certainty.

COMPONENTS OF FINANCIAL STATEMENTS

A complete set of financial statements comprises:
 a statement of financial position as at the end of the period;
 a statement of profit or loss and other comprehensive income for the period;
 a statement of changes inequity for the period;
 a statement of cash flows for the period;
 notes, comprising significant accounting policies and other explanatory
information;
 comparative information in respect of the preceding period
 a statement of financial position as at the beginning of the preceding period when
an entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements, or when it reclassifies items in its
financial statements

STATEMENT OF FINANCIAL POSITION

A statement of financial position presents the assets, liabilities, and equity.

ASSETS
An entity must normally present a classified statement of financial position, separating
current and noncurrent assets and liabilities. Only if a presentation based on liquidity
provides information that is reliable and more relevant may the current / noncurrent split
be omitted.

An entity shall classify an asset as current when:

 It expects to realize the asset, or intends to sell or consume it, in its normal
operating cycle
 It holds the asset primarily for the purpose of trading
 It expects to realize the asset with in twelve months after the reporting period
 The asset is cash or a cash equivalent (as defined in IAS 7) unless the asset is
restricted from being exchanged or used to settle a liability for at least twelve
months after the reporting period.

Normal Operating Cycle – The time between the acquisition of assets for processing
and their realization cash or cash equivalents. When the entity’s normal operating cycle
is not clearly identifiable, its duration is assumed to be twelve months.

Line items under current assets are

 Cash and cash equivalents
 Trade and other receivables

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  Financial asset at Fair Value through Profit or Loss
 Inventories
 Prepaid expenses
 The caption “noncurrent assets” is a residual definition. PAS1 provides that an
entity shall classify all other assets as non-current.
 The following are examples of non-current assets:
 Property, plant, and equipment
 Intangible assets
 Investment property
 Financial assets that are not expected to be realized in cash in the entity’s
normal operating cycle or within twelve months after the reporting period

LIABILITIES
An entity shall classify a liability as current when:
 It expects to settle the liability in its normal operating cycle
 It holds the liability primarily for the purpose of trading
 The liability is due to be settled within twelve months after the reporting period
 The entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period

Current liabilities include

 Trade and other payables
 Current provisions
 Short-term borrowings
 Current portion of long-term debt
 Current tax liability

An entity shall classify all other liabilities as non-current, such as:

 Long term notes payable that are due beyond 12 months from the end of the
reporting period
 Bonds payable that are due beyond twelve months after the reporting period
 Long-term notes payable that are due within twelve months after the reporting
period, but which terms is extended on along-term basis and negotiation has
been completed before the end of the reporting period.

An entity classifies its financial liabilities as current when they are due to be settled
within twelve months after the end of the reporting period, even if:
 The original term was for a period longer than twelve months; and
 The intention is supported by an agreement to refinance, or reschedule the
payments, on a long-term basis is completed after the end of the reporting period
and completed before the financial statements are authorized for issue.

If the entity has the discretion to refinance, or to rollover the obligation for at least twelve
months after the end of the reporting period under an existing loan facility, it classifies
the obligation as non-current, even if it would be due within a shorter period.

46
If a liability has become payable on demand because an entity has breached an
undertaking under a long-term loan agreement on or before the end of the reporting
period, the liability is current, even if the lender has agreed, after the end of the
reporting period and before the authorization of the financial statements for issue, not to
demand payment as a consequence of the breach. However, the liability is classified as
non-current if the lender agreed by the end of the reporting period to provide a period of
grace ending at least 12 months after the end of the reporting period, with in which the
entity can rectify the breach and during which the lender cannot demand immediate
repayment.

EQUITY
Equity is the residual interest in the assets of the entity after deducting all the liabilities.
Simply put, equity means net asset or total assets minus total liabilities.

The account name in reporting the equity of an entity depends on the form of the
business organization:

Soleproprietorship Owner’sequity
Partnership Partner’sequity
Corporation Stockholders’ equityor
shareholders’equity

FORMS OF THE STATEMENT OF FINANCIAL POSITION

A statement of financial position may be prepared using any of the following formats:
 Account form, which looks like a T account, where assets are listed on the left
side of the statement while liabilities and equity are listed on the right side
 Report form presents the assets, liabilities, and equity in a continuous format.
Liabilities are presented after total assets and equity accounts are listed after the
liabilities section
 Financial position form emphasizes working capital of the firm. In this format, net
assets are equal to the equity.

STATEMENT OF COMPREHENSIVE INCOME

Comprehensive income is the change of equity during a period other than changes
resulting from transactions with owners in their capacity as such. Comprehensive
income includes profit or loss and other comprehensive income.

Profit and Loss is the total income less expenses excluding the components of other
comprehensive income. It shall include line items that present the following amounts for
the period:
 revenue, presenting separately interest revenue calculated using the effective
interest method and insurance revenue
 gains and losses arising from the derecognition of financial assets measure data
amortized cost
 insurance service expenses from contracts issued within the scope of IFRS 17
 income or expenses from reinsurance contracts held

47
  finance costs
 impairment losses (including reversals of impairment losses or impairment gains)
determined in accordance with Section 5.5 of IFRS 9
 insurance finance income or expenses from contracts issued within the scope of
IFRS 17
 finance income or expenses from reinsurance contracts held
 share of the profit or loss of associates and joint ventures accounted for using the
equity method
 if a financial asset is reclassified out of the amortized cost measurement category
so that it is measured at fair value through profit or loss, any gain or loss arising
from a difference between the previous amortized cost of the financial asset and
its fair value at the reclassification date (as defined in IFRS 9)
 if a financial asset is reclassified out of the fair value through other
comprehensive income measurement category so that it is measured at fair
value through profit or loss, any cumulative gain or loss previously recognized in
other comprehensive income that is reclassified to profit or loss;
 tax expense
 a single amount for the total of discontinued operations

Other comprehensive income comprises Items of income and expenses including

reclassification adjustments that are not included in Profit and Loss as required by a
standard or interpretation. There are two types of OCI items, those that are reclassified
to profit or loss and those that are reclassified to Retained Earnings.

Components of OCI that will be reclassified subsequently to profit, or loss include the
following:
 Unrealized gain or loss on debt investments measured at fair value through other
comprehensive income
 Unrealized gain or loss from derivative contracts designated as cash flow hedge
 Translation gains and losses of foreign operations

Components of OCI that will be reclassified subsequently to retained earnings include

the following:
 Unrealized gain or loss on equity investments measured at fair value through
other comprehensive income
 Change in Revaluation Surplus
 Remeasurement gains and losses for defined benefit plans
 Change in fair value arising from credit risk for financial liabilities measured at fair
value through profit or loss

An entity shall disclose the following items in the statement of comprehensive income
as allocations of profit or loss for the period:
 Profit or loss for the period attributable to Minority interest and Owners of the
parent.
 Total comprehensive income for the period attributable to Minority interest and
Owners of the parent.

48
Statement of comprehensive income present income and expense for a given reporting
period. An entity shall present all items of income and expense recognized in a period:
 In a single statement of comprehensive income, or
 In two statements: a statement displaying components of profit or loss (separate
income statement) and a second statement beginning with profit or loss and
displaying components of other comprehensive income (statement of
comprehensive income).

An entity shall present either an analysis of expenses using a classification based on

either the nature of expenses or their function within the entity, whichever provides
information that is reliable and more relevant.

Nature of expense method – Expenses are aggregated in the income statement

according to their nature and are not reallocated among various functions within the
entity.

Revenue X
Other income X
Changes in inventories of finished goods and working X
progress
Raw materials and consumables used X
Employee benefit costs X
Depreciation and amortization X
Other expense X
Total expense (X)
Profit X

Function of expense or cost of sales method – Classifies expenses according to

their function as part of cost of sales or, for example, the cost of distribution or
administrative activities.

Revenue X
Cost of sales (X)
Gross profit X
Other income X
Distribution costs (X)
Administrative expenses (X)

Other expenses (X)

Income before tax X
Income tax expense (X)
Net income X

An entity classifying expenses by function shall disclose additional information on the

nature of expenses, including depreciation and amortization expense and employee

49
benefits expense. An entity shall not present any items of income and expense as
extraordinary items, either on the face of the income statement or in the notes

STATEMENT OF CHANGES IN EQUITY

An entity shall present a statement of changes in equity showing in the statement:
 Total comprehensive income for the period, showing separately the total amounts
attributable to owners of the parent and to non‑controlling interests
 For each component of equity, the effects of retrospective application or retrospective
restatement recognized in accordance with PAS 8
 For each component of equity, a reconciliation between the carrying amount at the
beginning and the end of the period, separately (as a minimum) disclosing changes
resulting from:
i. profit or loss;
ii. other comprehensive income; and
iii. transactions with owners in their capacity as owners, showing separately
contributions by and distributions to owners and changes in ownership
interests in subsidiaries that do not result in a loss of control.

An entity shall present, either in the statement of changes in equity or in the notes, the
amount of dividends recognized as distributions to owners during the period, and the
related amount per share.

STATEMENT OF CASH FLOWS

Cash flow information provides users of financial statements with a basis to assess the
ability of the entity to generate cash and cash equivalents and the needs of the entity to
utilize those cash flows.

Classification
The statement of cash flows presents information on the inflows and outflows of cash
and cash equivalent classified into operating activities, investing activities, and financing
activities.

Cash flows from operating activities are primarily derived from the principal
revenue‑producing activities of the entity. Examples of cash flows from operating
activities are:
 cash receipts from the sale of goods and the rendering of services;
 cash receipts from royalties, fees, commissions and other revenue;
 cash payments to suppliers for goods and services;
 cash payments to and on behalf of employees;
 cash payments or refunds of income taxes unless they can be specifically
identified with financing and investing activities; and
 cash receipts and payments from contracts held for dealing or trading purposes.

An entity may hold securities and loans for dealing or trading purposes, in which case
they are similar to inventory acquired specifically for resale. Therefore, cash flows
arising from the purchase and sale of dealing or trading securities are classified as

50
operating activities. Similarly, cash advances and loans made by financial institutions
are usually classified as operating activities since they relate to the main
revenue‑producing activity of that entity.

Investing activities are the cash flows derived from the acquisition and disposal of long-
term assets and other investment not included in cash equivalents. Only expenditures
that result in a recognized asset in the statement of financial position are eligible for
classification as investing activities. Examples of cash flows arising from investing
activities are:
 cash payments to acquire property, plant and equipment, intangibles and other
long‑term assets. These payments include those relating to capitalized
development costs and self‑constructed property, plant and equipment;
 cash receipts from sales of property, plant and equipment, intangibles and other
long‑term assets;
 cash payments to acquire equity or debt instruments of other entities and
interests in joint ventures (other than payments for those instruments considered
to be cash equivalents or those held for dealing or trading purposes);
 cash receipts from sales of equity or debt instruments of other entities and
interests in joint ventures (other than receipts for those instruments considered to
be cash equivalents and those held for dealing or trading purposes);
 cash advances and loans made to other parties (other than advances and loans
made by a financial institution);
 cash receipts from the repayment of advances and loans made to other parties
(other than advances and loans of a financial institution);
 cash payments for futures contracts, forward contracts, option contracts and
swap contracts except when the contracts are held for dealing or trading
purposes, or the payments are classified as financing activities; and
 cash receipts from futures contracts, forward contracts, option contracts and
swap contracts except when the contracts are held for dealing or trading
purposes, or the receipts are classified as financing activities.

Financing activities include cash transactions affecting non-trade liabilities, and

shareholders’ equity. Examples of cash flows arising from financing activities are:
 cash proceeds from issuing shares or other equity instruments;
 cash payments to owners to acquire or redeem the entity’s shares;
 cash proceeds from issuing debentures, loans, notes, bonds, mortgages and
other short-term or long‑term borrowings;
 cash repayments of amounts borrowed; and
 cash payments by a lessee for the reduction of the outstanding liability relating to
a lease.

Interest and dividends

Cash flows from interest and dividends received and paid shall each be disclosed
separately. Each shall be classified in a consistent manner from period to period as
either operating, investing or financing activities.

51
Interest paid and interest and dividends received may be classified as operating cash
flows because they enter into the determination of profit or loss. Alternatively, interest
paid and interest and dividends received may be classified as financing cash flows and
investing cash flows respectively, because they are costs of obtaining financial
resources or returns on investments.

Dividends paid may be classified as a financing cash flow because they are a cost of
obtaining financial resources. Alternatively, dividends paid may be classified as a
component of cash flows from operating activities in order to assist users to determine
the ability of an entity to pay dividends out of operating cash flows.

Received Paid
Interest Operating(or Investing) Operating(or Financing)
Dividends Operating(or Investing) Financing(or Operating)

Taxes on income
Cash flows arising from taxes on income shall be separately disclosed and shall be
classified as cash flows from operating activities unless they can be specifically
identified with financing and investing activities.

Presentation of Cash Flows

An entity shall report cash flows from operating activities using either:
 the direct method, whereby major classes of gross cash receipts and gross cash
payments are disclosed; or
 the indirect method whereby profit or loss is adjusted for the effects of
transactions of a non‑cash nature, any deferrals or accruals of past or future
operating cash receipts or payments, and items of income or expense associated
with investing or financing cash flows.

Under the direct method, information about major classes of gross cash receipts and
gross cash payments may be obtained either:
 from the accounting records of the entity; or
 by adjusting sales, cost of sales (interest and similar income and interest
expense and similar charges for a financial institution) and other items in the
statement of comprehensive income for:
i. changes during the period in inventories and operating receivables and
payables;
ii. other non‑cash items; and
iii. other items for which the cash effects are investing or financing cash flows.

Under the indirect method, the net cash flow from operating activities is determined by
adjusting profit or loss for the effects of:
 changes during the period in inventories and operating receivables and payables;
 non‑cash items such as depreciation, provisions, deferred taxes, unrealized
foreign currency gains and losses, and undistributed profits of associates; and
 all other items for which the cash effects are investing or financingcashflows.

52
Based on the foregoing, the following guidelines may be used in adjusting accrual basis
net income to the cash basis net income under the indirect method:
NetIncome
+ Depreciation,amortization,andothernoncashexpenses
- Allincreasesintradenoncashcurrent assets
+ Alldecreasesintradenoncashcurrent assets
+ Allincreasesintradecurrentliabilities
- Alldecreasesintradecurrentliabilities
- Gainondisposalofproperty
+ Lossondisposalofproperty

Investing and financing activities are presented usingdirectmethod, separating major

classes of gross cash receipts and gross cash payments arising from these activities.

NOTESTOTHEFINANCIALSTATEMENTS
Thenotesmust:
 Presentinformationaboutthebasisofpreparationofthefinancialstatementsandthe
specific accounting policies used;
 Disclose any information required by PFRSs that is not presented on the face of
the statement of financial position, incomestatement, statement of
changesinequity, or statement of cash flows
 Provide additional information that is not presented on the face of the statement
of financial position, income statement, statement of changesin equity,
orstatement of cash flows that is deemed relevant to an understanding of any of
them.

Notesshouldbecross-referencedfromthefaceofthefinancialstatementstotherelevant
note.The notes should normally be presented in the following order:
 AstatementofcompliancewithPFRSs
 Asummaryofsignificantaccountingpoliciesapplied,including:
i. Themeasurementbasis(orbases)usedinpreparingthefinancial statements;
and
ii. The other accounting policies used that are relevant to an understanding
of the financial statements.
 Supporting information for items presented on the face of the statement of
financial position, income statement, statement of changes in equity, and
statement of ash flows, in the order in which each statement and each line item is
presented.
 Otherdisclosures,including:
i. Contingentliabilitiesandunrecognizedcontractualcommitments
ii. Non-financial disclosures, such as the entity's financial risk management
objectives and policies.

Disclosureofjudgments-anentitymustdisclose,inthesummaryofsignificantaccounting
policies or other notes, the judgments, apart from thoseinvolving estimations, that
53
management
hasmadeintheprocessofapplyingtheentity'saccountingpoliciesthathavethemostsignificant
effect on the amounts recognized in the financial statements.

HIERARCHYINTHEFORMATIONOFACCOUNTING POLICIES
When an IFRS specifically applies to a transaction, other event or condition, the
accounting policy or policies applied to that item shall be determined by applying the
IFRS.

In the absence of an IFRS that specifically applies to a transaction, other event or

condition, managementshall use itsjudgement in developing andapplying an
accountingpolicy that results in information that is:
 relevanttotheeconomicdecision‑makingneedsofusers; and
 reliable,inthatthefinancialstatements:
i. representfaithfullythefinancialposition,financialperformanceandcash flows
of the entity;
ii. reflecttheeconomicsubstanceoftransactions,othereventsandconditions,
and not merely the legal form;
iii. areneutral,freefrombias;
iv. areprudent;and
v. arecompleteinallmaterialrespects.

In making the judgement described above, management shall refer to, and consider the
applicability of, the following sources in descending order:
 therequirementsinIFRSsdealingwithsimilarandrelatedissues;And
 the definitions, recognition criteria and measurement concepts for assets,
liabilities, income and expenses in the Conceptual Framework for Financial
Reporting (Conceptual Framework).

Management may also consider the most recent pronouncements of other

standard‑settingbodiesthatuseasimilarconceptualframeworktodevelopaccountingstandar
ds,
otheraccountingliteratureandacceptedindustrypractices,totheextentthatthesedonotconflic
t with the sources mentioned above.

GENERALFEATURESINTHEPRESENTATIONOFTHEFINANCIALSTATEMENTS

FAIRPRESENTATIONANDCOMPLIANCEWITH PFRS
Financial statements shall present fairly the financial position, financial performance and
cash flows of an entity. In virtually all circumstances, an entity achieves a fair
presentation by compliance with applicable IFRSs.

An entity whose financial statements comply with IFRSs shall make an explicit and
unreserved statement of such compliance in the notes. An entity shall not describe
financial statements as complying with IFRSs unless they comply with all the
requirements of IFRSs.

54
Fair presentation requires the faithful representation of the effects of transactions, other
events and conditions in accordance with the definitions and recognition criteria for
assets, liabilities, income and expenses set out in the Conceptual Framework for
Financial Reporting (Conceptual Framework). A fair presentation also requires an entity:
 toselectandapplyaccountingpoliciesinaccordancewithIAS8AccountingPolicies,
Changes in Accounting Estimates and Errors. IAS 8 sets out a hierarchy of
authoritative guidance that management considers in the absence of an IFRS
that specifically applies to an item.
 to present information, including accounting policies, in a manner that provides
relevant, reliable, comparable and understandable information.
 to provide additional disclosures when compliance with the specific requirements
in IFRSs is insufficient to enable users to understand the impact of particular
transactions, other events and conditions on the entity’s financial position and
financial performance.

An entity cannot rectify inappropriate accounting policies either by disclosure of the

accounting policies used or by notes or explanatory material.

PAS 1 acknowledges that, in extremely rare circumstances, management may conclude

thatcompliance with anPFRSrequirementwould besomisleadingthatitwould conflict
withthe objective of financial statements set out in the Framework. In such a case, the
entity is required
todepartfromthePFRSrequirement,withdetaileddisclosureofthenature,reasons,andimpact
of the departure.

GOING CONCERN
Anentityshallpreparefinancialstatementsonagoingconcernbasisunlessmanagement
eitherintendstoliquidatetheentityortoceasetradingorhasnorealisticalternativebuttodoso.
AnentitypreparingPFRSfinancialstatementsispresumedtobeagoingconcern.Goingconcer
n means that the accounting entity is viewed as continuing in operation indefinitely in
the absence of evidence to the contrary.

When management is aware, in making its assessment, of material uncertainties related

to events or conditions that may cast significant doubt upon the entity’s ability to
continue as a going concern, the entity shall disclose those uncertainties.

When an entity does not prepare financial statements on a going concern basis, it shall
disclose that fact, together with the basis on which it prepared the financial statements
and the reason why the entity is not regarded as a going concern.

ACCRUALBASIS
Anentityshallprepareitsfinancialstatements,exceptforcashflowinformation,usingthe
accrual basis of accounting. When the accrual basis of accounting is used, an entity
recognizes items as assets, liabilities, equity, income and expenses (the elements of

55
financial statements) when they satisfy the definitions and recognition criteria for those
elements in the Conceptual Framework.

MATERIALITYANDAGGREGATION
An entity shall present separately each material class of similar items. An entity shall
presentseparatelyitemsofadissimilarnatureorfunctionunlesstheyareimmaterial.Ifalineitem
is not individually material, it is aggregated with other items either in those statements or
in the
notes.Anitemthatisnotsufficientlymaterialtowarrantseparatepresentationinthosestatemen
ts maywarrant separatepresentationinthe notes. But iftheresulting disclosure
isnotmaterial, an entity need not provide a specific disclosure even if required by PFRS.

OFFSETTING
Anentityshallnotoffsetassetsandliabilitiesorincomeandexpenses,unlessrequiredor
permitted by an IFRS. An entity reports separately both assets and liabilities, and
income and expenses.Measuringassetsnetofvaluationallowances—
forexample,obsolescenceallowances on inventories and doubtful debts allowances on
receivables—is not offsetting.

FREQUENCYOFREPORTING
An entity shall present a complete set of financial statements (including comparative
information)atleastannually.Whenanentitychangestheendofitsreportingperiodandpresent
s financial statements for a period longer or shorter than one year, an entity shall
disclose, in addition to the period covered by the financial statements:
 thereasonforusingalongerorshorterperiod, and
 the fact that amounts presented in the financial statements are not entirely
comparable.

Normally, an entity consistently prepares financial statements for a one‑year period.

However,forpracticalreasons,someentitiesprefertoreport,forexample,fora52‑weekperiod.
This Standard does not preclude this practice.

COMPARATIVEINFORMATION
MinimumComparativeInformation
Except when IFRSs permit or require otherwise, an entity shall present comparative
information in respect of the preceding period for all amounts reported in the current
period’s financial statements.

Anentityshallpresent,asaminimum,twostatementsoffinancialposition,twostatements of
profit or loss and other comprehensive income, two separate statements of profit or loss
(if presented), two statements of cash flows and two statements of changes in equity,
and related notes.

Anentityshallincludecomparativeinformationfornarrativeanddescriptiveinformationif it
isrelevanttounderstandingthecurrentperiod’sfinancialstatements. Insomecases,narrative
information provided in the financial statements for the preceding period(s) continues to

56
be relevant in the current period. For example, an entity discloses in the current period
details of a legal dispute, the outcome of which was uncertain at the end of the
preceding period and is yet to be resolved. Users may benefit from the disclosure of
information that the uncertainty existed at the end of the preceding period and from the
disclosure of information about the steps that have been taken during the period to
resolve the uncertainty.

Additionalcomparativeinformation
Anentitymaypresentcomparativeinformationmayconsistofoneormorestatementsbut need
not comprise a complete set offinancial statements. For example,an entitymay present a
thirdstatement of profit or lossandothercomprehensive
income(therebypresentingthecurrent period, the preceding period and one additional
comparative period). However, the entity is not
requiredtopresentathirdstatementoffinancialposition,athirdstatementofcashflowsorathird
statement of changes in equity (i.e. an additional financial statement comparative). The
entity is required to present, in the notes to the financial statements, the comparative
information related to that additional statement of profit or loss and other comprehensive
income.

Whenthirdstatementoffinancialpositionisrequired
An entity shall present a third statement of financial position as at the beginning of
thepreceding period in addition to the minimum comparative financial statements if:
 it applies an accounting policy retrospectively, makes a retrospective restatement
of items in its financial statements or reclassifies items in its financial statements;
and
 theretrospectiveapplication,retrospectiverestatementor
 thereclassificationhasamaterialeffectontheinformationinthestatementoffinancial
position at the beginning of the preceding period.

Underthesecircumstances,anentityshallpresent threestatements of financialpositionas

at:
 theendofthecurrent period;
 theendoftheprecedingperiod;and
 thebeginningoftheprecedingperiod.

CONSISTENCYOFPRESENTATION
Anentityshallretainthepresentationandclassificationofitemsinthefinancialstatements from
one accounting period to the next. Change is allowed under the following
circumstances:
 itisapparent,followingasignificantchangeinthenatureoftheentity’soperationsor a
review of its financial statements, that another presentation or classification
would be more appropriate having regard to the criteria for the selection and
application of accounting policies in IAS 8; or
 anIFRSrequiresachangein presentation.

57
LIMITATIONSOFTHEFINANCIALSTATEMENTS
Commonlimitationsontheusefinancialstatementsare
 Useofdifferentmeasurementbases.Elementsrecognizedinfinancialstatementsar
e quantifiedinmonetaryterms.Considerationofthequalitativecharacteristicsofuseful
financial information and of the cost constraint is likely to result in the selection of
different measurement bases for different assets, liabilities, income and
expenses.
 Inflationaryeffects.Assetsmeasuredathistoricalcostsreflectthelevelofpurchasing
powerwhenthoseassetsareacquiredatdifferentdates.Suchpurchasecostsalbeit
atdifferentdatesarethebasisofthepresentationoftheseassetsinthestatementof
financialpositionandofthecomputationofdepreciationexpensesinthestatementof
comprehensive income.Iftheinflationrateisrelatively high,theamountsreportedin
the financial statements will appear inordinately low since under the cost model,
the assets are not adjusted for inflation. Hence, the amounts reflected in the
financial statements are mixture of pesos with different levels of purchasing
power.
 Measurementuncertainty.Theuseofreasonableestimatesisanessentialpartofthe
preparation of financial information. In some cases, the level of uncertainty
involved in estimating a measure of an asset or liability may be so high that it
may be
questionablewhethertheestimatewouldprovideasufficientlyfaithfulrepresentation of
that asset or liability and of any resulting income, expenses or changes in equity.
 Nowalwayscomparableacrosscompanies.Differentcompaniesmayapplydifferen
t accounting policies and use different accounting periods. While accounting
policies
aredisclosedinthefinancialstatements,theusersoffinancialstatementscanhardly
adjust the reported figures in the financial statements for comparability. Any one
period may vary from the normal operating results of a business due to
seasonality effects.
 Non-financial information is not reported. The notes to financial statements
provide textual description of what was reported in the face of the financial
statements. However, thefinancial statements donot reportthe levelof
corporategovernanceof the company, the moral and efficiency ofcompany
personnel or businessethics, the effect of the business to the environment, or the
company’s contribution to the local community. Financial statements may report
high net income but fail to indicate its degrading effect to the environment.
 No predictive value. The financial statements report past events, but they do
not provide any value that predict what will happen in the future. A company may
report
billionsofincomesintheprecedingyears,yetanewlyelectedpresidentofthecountry
cancels its contract on which it was relying.

FUNCTIONOFTHESECURITIESANDEXCHANGECOMMISSIONS(SEC)
The Commission shall have the powers and functions provided by the Securities
Regulation Code, Presidential Decree No. 902-A, as amended, the Corporation Code,
the Investment Houses Law, the Financing Company Act, and other existing laws.

58
Under Section 5 of the Securities Regulation Code, Rep. Act. 8799, the Commission
shall have, among others, the following powers and functions:
a. Have jurisdiction andsupervision over all corporations, partnerships or
associations who are the grantees of primary franchises and/or a license or
permit issued by the Government;
b. Formulate policies and recommendations on issues concerning the securities
market, advise Congress and other government agencies on all aspects of the
securities market and propose legislation and amendments thereto;
c. Approve, reject, suspend, revoke or require amendments to registration
statements, and registration and licensing applications;
d. Regulate,investigateorsupervisetheactivitiesofpersonstoensurecompliance;
e. Supervise, monitor, suspend or take over the activities of exchanges, clearing
agencies and other SROs;
f. Impose sanctions for the violation of laws and the rules, regulations and orders
issued pursuant thereto;
g. Prepare,approve,amendorrepealrules,regulationsandorders,andissueopinionsand
provide guidance on and supervise compliance with such rules, regulations and
orders;
h. Enlist the aid and support of and/or deputize any and all enforcement agencies of
the
Government,civilormilitaryaswellasanyprivateinstitution,corporation,firm,associati
on or person in the implementation of its powers and functions under this Code;
i. Issueceaseanddesistorderstopreventfraudorinjurytotheinvestingpublic;
j. Punish for contempt of the Commission, both direct and indirect, in accordance
with the pertinent provisions of and penalties prescribed by the Rules of Court;
k. Compel the officers of any registered corporation or association to call meetings
of stockholders or members thereof under its supervision;
l. Issuesubpoenaducestecumandsummonwitnessestoappearinanyproceedingsofth
e Commission and in appropriate cases, order the examination, search and
seizure of all documents, papers, filesand records, taxreturns, and books of
accountsof any entity or person under investigation as may be necessary for the
proper disposition of the cases before it, subject to the provisions of existing
laws;
m. Suspend, or revoke, after proper notice and hearing the franchise or certificate of
registration of corporations, partnerships or associations, upon any of the
grounds provided by law; and
n. Exercise such other powers as may be provided by law as well as those which
may be implied from, or which are necessary or incidental to the carrying out of,
the express powers granted the Commission to achieve the objectives and
purposes of these laws.

Under Section 5.2 of the Securities Regulation Code, the Commission’s jurisdiction over
allcasesenumeratedunderSection5ofPD902-AhasbeentransferredtotheCourtsofgeneral
jurisdictionortheappropriateRegionalTrial Court.
TheCommissionshallretainjurisdictionover pending cases involving intra-corporate
disputes submitted for final resolution which should be resolved within one (1) year from

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the enactment of the Code. The Commission shall retain jurisdiction over pending
suspension of payments/rehabilitation cases filed as of 30 June 2000 until finally
disposed.

ConsideringthatonlySections2,4,and8ofPD902-A,asamended,havebeenexpressly
repealed by the Securities Regulation Code, the Commission retains the powers
enumerated in Section 6 of said Decree, unless these are inconsistent with any
provision of the Code.

PHILIPPINEFINANCIALREPORTINGFRAMEWORKSANDTHEREPORTINGENTITIES
Financialreportingframeworksapplicabletodifferentreportingentitiesareasfollows:

ReportingEntities FinancialReportingFrameworks
Largeand/orpubliclyaccountableentities FullPFRS/IFRS
Medium-sizedentities PFRSforSmallandMedium-SizedEntities
(PFRS/IFRS for SMEs)
Smallentities PFRSforSmall Entities
Microentities Incometax Reporting

LARGEAND/ORPUBLICLYACCOUNTABLEENTITIES
LargeentitiesarethosewithtotalassetsofmorethanP350millionortotalliabilitiesofmorethan
P250 million. Public entities are those that meet any of the following criteria:
 Holdersofsecondarylicensesissuesbyregulatoryagencies
 RequiredtofilefinancialstatementsunderPartIIofSRCRule68
 In the process of filing their financial statements for the purpose of issuing any
class of instrument in a public market
 ImbuedwithpublicinterestastheSECmayconsiderinthefuture

Large and/or public interest entities shall use the PFRS, as adopted by the Commission,
astheirfinancialreportingframework.However,asetoffinancialreportingframeworkothertha
n the full PFRS may be allowed by the Commission for certain sub-class (e.g., banks,
insurance companies) of these entities upon consideration of the pronouncements or
interpretations.

MEDIUM-SIZEDENTITIES
Medium-sizedentitiesarethosethatmeetallofthefollowingcriteria:
 Total assets of more than P100 million to P350million or total liabilities of more
than P100milliontoP250million.Iftheentityisaparentcompany,thesaidamountsshall
be based on the consolidated figures.
 NotrequiredtofilefinancialstatementsunderPartIIofSRCRule68
 Not in the process of filing their financial statements for the purpose of issuing
any class of instrument in a public market
 Notholdersofsecondarylicensesissuesbyregulatoryagencies

Medium-sizedentitiesshalluseastheirfinancialreportingframeworkthePFRSforSMEs as
adopted by the SEC. However, the following medium-sized entities shall be exempt

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from the
mandatoryadoptionofthePFRSforSME’sandmayinsteadapply,attheiroption,thefullPFRS:
 An SME which is a subsidiary of a foreign parent company reporting under the
full PFRS
 An SME which is a subsidiary of a foreign parent company which will be moving
towardsInternationalFinancialReportingStandardspursuanttotheforeigncountry’s
published convergence plan
 AnSMEeitherasasignificantjointventureorassociate,whichispartofagroupthat is
reporting under the full PFRS
 An SME which is a branch office or regional operating headquarter of a foreign
company reporting under the full PFRS
 AnSMEwhichhasasubsidiarythatismandatedtoreportunderthefullPFRS
 An SME which has a short-term projection that shows that it will breach the
quantitative thresholds set in the criteria for an SME. The breach is expected to
be significantandcontinuingduetoitslong-termeffectonthecompany’sassetorliability
size
 AnSMEwhichhascconcreteplantoconductaninitialpublicofferingwithinthenext two
years
 An SME which has been preparing financial statements using full PFRS and has
decided to liquidate
 Such other cases that the Commission may consider as valid exceptions from
the mandatory adoption of PFRS for SMEs

SMALL ENTITIES
Smallentitiesarethosethatmeetallofthefollowingcriteria:
 TotalassetsofbetweenP3milliontoP100millionortotalliabilitiesbetweenP3million
toP100million.Iftheentityisaparentcompany,thesaidamountsshallbebasedon the
consolidated figures.
 ArenotrequiredtofilefinancialstatementsunderPartIIofSRCRule68
 Arenotintheprocessoffilingtheirfinancialstatementsforthepurposeofissuingany
class of instruments in a public market
 Arenotholdersofsecondarylicensesissuesbyregulatoryagencies

Small entities shall use their financial reporting framework the PFRS for SEs as adopted
by the Commission. However, entities who have operations or investments that are
based or conducted in a different country with different functional currency shall not
apply this framework and should instead apply the full PFRS or PFRS for SMEs.

ThefollowingsmallentitiesshallalsobeexemptfromthemandatoryadoptionofthePFRS for
SEs and may instead apply, as appropriate, the full PFRS or PFRS for SMEs:
 A small entity which is a subsidiary of a foreign parent company reporting under
the full PFRS or PFRS for SMEs
 A small entity which is a subsidiary of a foreign parent company which will be
moving towards International Financial Reporting Standards or IFRS for SMEs
pursuant to the foreign country’s published convergence plan
 Asmallentityeitherasasignificantjointventureorassociate,whichispartofagroupthat

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 is reporting under the full PFRS or PFRS for SMEs
 A small entity which is a branch office or regional operating headquarter of a
foreign company reporting under the full PFRS or PFRS for SMEs
 A small entity which has a subsidiary that is mandated to report under the full
PFRS or PFRS for SMEs
 A small entity which has a short-term projection that shows that it will breach the
quantitative thresholds set in the criteria for a small entity. The breach is
expected to be significant and continuing due to its long-term effect on the
company’s asset size
 AsmallentitywhichhasbeenpreparingfinancialstatementsusingfullPFRSorPFRSfor
SMEs and has decided to liquidate
 Such other cases that the Commission may consider as valid exceptions from
the mandatory adoption of PFRS for SMEs

MICRO ENTITIES
Microentitiesarethosethatmeetallofthefollowingcriteria:
 TotalassetsandliabilitiesarebelowP3million
 ArenotrequiredtofilefinancialstatementsunderPartIIofSRCRule68
 Are not in the process of filing their financial statements for the purpose of
issuing anyclass of instruments in a public market
 Arenotholdersofsecondarylicensesissuesbyregulatoryagencies

Micro entities have the option to use as their financial reporting framework either the
incometaxbasis or PFRSfor SEs, provided however,thatthe
financialstatementsshallatleast consist of the Statement of Management’s Responsibility
(SMR), Auditor’s Report, Statement of
FinancialPosition,StatementofIncomeandNotestoFinancialStatements,allofwhichcoverth
e 2-year comparative periods, if applicable.

Inthe event whereanentitybreachesthe prescribed threshold intermsof totalassetsor

totalliabilitiesandthusitfallswithinadifferentclassification,theAuditedFinancialStatementsof
said entity shall be prepared in accordance with the higher framework.

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 UNIT IV

EVENTS AFTER THE REPORTING PERIOD

INTRODUCTION
IAS 10 Events After the Reporting Period contains requirements for when events after
the end of the reporting period should be adjusted in the financial statements. Adjusting
events are those providing evidence of conditions existing at the end of the reporting
period, whereas non-adjusting events are indicative of conditions arising after the
reporting period (the latter being disclosed where material).

LEARNING OBJECTIVES
After reading this unit, you should be able to:
1. Understand the concept and know the types of events after the reporting period.
2. Describe the recognition of adjusting and non-adjusting events.

LECTURE DISCUSSION

KEY DEFINITIONS
 Event after the reporting period: An event, which could be favorable or
unfavorable, that occurs between the end of the reporting period and the date that
the financial statements are authorized for issue.

 Adjusting event: An event after the reporting period that provides further evidence
of conditions that existed at the end of the reporting period, including an event that
indicates that the going concern assumption in relation to the whole or part of the
enterprise is not appropriate.

 Non-adjusting event: An event after the reporting period that is indicative of a

condition that arose after the end of the reporting period.

ACCOUNTING
Adjust financial statements for adjusting events - events after the balance sheet date
that provide further evidence of conditions that existed at the end of the reporting
period, including events that indicate that the going concern assumption in relation to
the whole or part of the enterprise is not appropriate.

Do not adjust for non-adjusting events - events or conditions that arose after the end of
the reporting period.

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If an entity declares dividends after the reporting period, the entity shall not recognize
those dividends as a liability at the end of the reporting period. That is a non-adjusting
event.

GOING CONCERN ISSUES ARISING AFTER END OF THE REPORTING PERIOD

An entity shall not prepare its financial statements on a going concern basis if
management determines after the end of the reporting period either that it intends to
liquidate the entity or to cease trading, or that it has no realistic alternative but to do so.

DISCLOSURE
Non-adjusting events should be disclosed if they are of such importance that non-
disclosure would affect the ability of users to make proper evaluations and decisions.
The required disclosure is (a) the nature of the event and (b) an estimate of its financial
effect or a statement that a reasonable estimate of the effect cannot be made.

A company should update disclosures that relate to conditions that existed at the end of
the reporting period to reflect any new information that it receives after the reporting
period about those conditions.

Companies must disclose the date when the financial statements were authorized for
issue and who gave that authorization. If the enterprise's owners or others have the
power to amend the financial statements after issuance, the enterprise must disclose
that fact.

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