Prepared by: ABEJAY H.

SELDA, CPA__
E-mail Address: [email protected]________

Central Luzon State University

Science City of Muñoz 3120
Nueva Ecija, Philippines

Instructional Module for the Course

ACCTG 3100 LEC AND LAB / Intermediate Accounting 3

Module
Topic 2 Financial Statements

Overview

This course is designed to provide the student with an in-depth

exposure about financial statements, components of financial statements,
objective of financial statements, objective of financial reporting understands
the primary responsibility for the preparation of financial statements identify
the general features in the preparation of financial statements

I. Objectives

At the end of this module, the learners are expected;

 To identify the components of financial statements

 To know the objective of financial statements

 To know the objective of financial reporting

 To understand the primary responsibility for the preparation of

financial statements

 To identify the general features in the preparation of financial

 ACCTG 3100/ INTERMEDIATE ACCOUNTING 3

statements

II. Learning Activities

Financial Statements

Financial Statements are the means by which the information accumulated and
processed in financial accounting is periodically communicated to the users.

Financial Statements are a structured financial representation of the financial

position and financial performance of an entity.

General purpose financial statements

General purpose financial statements are those statements 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.

Reports prepared at the request on an entity’s management or bankers are NOT

general purpose financial statements because they are prepared specifically to
meet the needs of management or bankers.

Compose of financial statements

1. Statement of financial position

2. Income Statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of SIGNIFICANT accounting policies and
other explanatory information

Many entities also present reports and statements such as environmental reports
and value added statement, particularly in industries in which environmental
factors are significant and when employees regarded as an important user
group.

However, such statements and reports are NOT components of financial

statements.

Objective of financial statements

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The objective of general purpose 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 stewardship of management of

the resources entrusted to it.

To meet this objective, financial statements provide information about the

following:

a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses
e. Contributions by and distributions to owners in their capacity as owners
f. Cash flows

Such information, along with other information in the notes, would assist users
of financial statements in predicting the entity's cash flows and in particular their
timing and certainty.

However, financial statements DO NOT provide all the information that users
may need to make economic decisions.

The reason is that the financial statements largely portray the financial effects of
past events and do not necessarily provide nonfinancial information.

Financial Position

The financial position comprises the assets, liabilities and equity of an entity
at a particular moment in time.

Specifically, financial position pertains to the liquidity, solvency, and the need of
the entity for additional financing.

This information is pictured in the statement of financial position.

Financial Performance

The financial performance comprises the revenue, expenses and net income
or loss of an entity for a period of time.

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Performance is the level of income earned by the entity through the efficient and
effective use of its resources.

The financial performance of an entity is also known as results of operations and

is portrayed in the income statement and statement of comprehensive income.

Cash Flow

Cash flows are the cash receipts and cash payments arising from the operating,
investing and financing activities of the entity.

The information about cash receipts and cash payments is presented in the
statement of cash flows.

Cash flow information is useful in assessing the ability of the entity to generate
cash and cash equivalents.

Financial Reporting

Financial reporting is the provision of financial information is useful to them in

making economic decisions and for assessing the effectiveness of the entity's
management.

Financial reports include not only financial statements but also other
information such as financial highlights, summary of important financial figures,
analysis of financial statements and significant ratios.

Financial reports also include nonfinancial information such as description of

major products and a listing of corporate officers and directors.

Objective of financial reporting

Under the Conceptual framework for Financial Reporting, the objective of 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
about providing resources to the entity.

Simply stated, the overall objective of financial reporting is to provide information

that is useful for decision making.

Target users of financial reporting

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General purpose financial reporting is directed primarily to the existing and

potential investors, lenders and other creditors which compose the primary user
group.

The reason is that existing and potential investors, lenders and other creditors
have the most critical and immediate need for information in financial
reports.

As a matter of fact, the primary users of financial information are the parties that
provide resources to the entity.

Moreover, information that meets the needs of the specified primary users is likely
to meet the needs of other users such as employees, customers, governments and
their agencies.

The management of a reporting entity is also interested in financial information

about the entity.

However, management need not rely on general purpose financial reports because
it is able to obtain or access additional financial information internally.

Specific objectives of financial reporting

Specifically, the Conceptual Framework for Financial Reporting states the

following objectives of financial reporting:

a. To provide information useful in making investing and credit decisions about

providing resources to the entity.
b. To provide information useful in assessing the cash flow prospects of the
entity.
c. To provide information about entity resources, claims and changes in
resources and claim

Limitations of financial reporting

a. General purpose financial reports DO NOT and cannot provide all of the
financial information that existing and potential investors, lenders, and other
creditors need.

b. General purpose financial reports are NOT designed to show the value of a
reporting entity but these reports provide information to help the primary users
estimate the value of entity.

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c. General purpose financial reports are intended to provide common

information to users and accommodate every specific request for information.

d. To a large extent, financial reports are based on estimate and judgement

rather than exact depiction.

Responsibility for financial reporting

The management of an entity has the primary responsibility for the preparation
and presentation of financial statements.

General features for financial statements

1. Fair Presentation and compliance with PFRS

2. Going Concern
3. Accrual basis
4. Materiality and aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation

Fair Presentation

The financial statements shall present fairly the financial position, financial
performance and cash flows of an entity.

Virtually, in all circumstances, fair presentation is achieved if the financial

statements are prepared in accordance with the Philippine Financial Reporting
Standards which represent the GAAP in the Philippines.

The application of Philippine Financial Reporting Standards, with additional

disclosure when necessary, is presumed to result in financial statements that
achieve a fair presentation.

An entity whose financial statements comply with PFRS shall make an explicit
and unreserved statement of such compliance in the notes.

Fair presentation is defined as faithful representation of the effects of

transactions and other events in accordance with the definitions and recognition
criteria for assets, liabilities, income and expenses laid down in the Conceptual
Framework.

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Fair presentation requires an entity:

a. To select and apply accounting policies in accordance with PFRS

b. To present information, including accounting policies, in a manner that
provides relevant and faithfully represented financial information.
c. To provide additional disclosures necessary for the users to understand the
entity's financial statements

An entity cannot rectify inappropriate accounting policies either by

disclosure of the accounting policies used or by notes or explanatory information.

Departure from Standard

In the extremely rare circumstances in which management concludes that

compliance with a requirement in a standard would be so misleading, the entity
shall depart from that requirement provided that relevant regulatory Conceptual
Framework requires, or otherwise does not prohibit, such departure.

Thus, an entity is permitted to depart from a standard:

1. In extremely rare circumstances.

2. When management concludes that compliance with the standard would be
misleading
3. When the departure from the standard is necessary to achieve fair
presentation.
4. When the regulatory Conceptual Framework requires or otherwise does not
prohibit such a departure.

In such circumstances, it is incumbent upon the entity to disclose the following:

1. The management has concluded that the financial statements

present fairly the financial position, financial performance and cash
flows of the entity.
2. That the entity has complied with applicable standards except that it
has departed from a particular requirement to achieve a fair
presentation.
3. The title of the standard from which the entity has departed, that the
nature of the departure, including the treatment the standard would
require, the reason why that treatment would be so misleading and
the treatment adopted.
4. For each period presented, the financial impact of the departure on
each item in the financial statements that would have been reported in
complying with the requirement.

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Going Concern

Going concern means that the accounting entity is viewed continuing in

operation indefinitely in the absence of evidence to the contrary .

Going concern is also known as continuity assumption.

In other words, financial statements are prepared normally on the assumption

that the entity shall continue in operation for the foreseeable future.

Thus, assets are normally recorded at original acquisition cost. As a rule, market
values are ignored.

However, some standards require measurement of certain assets at fair value.

Going concern is particularly relevant when management shall make an estimate

of the expected outcome of future events, such as the recoverability of accounts
receivable and the useful life of noncurrent assets.

If the financial statements are not prepared on a going concern basis, such fact
shall be disclosed together with the measurement basis and the reason therefor.

Accrual basis

An entity shall prepare the financial statements, using the accrual basis of
accounting except for cash flow information.

Under accrual basis, the effects of transactions and other events are recognized
when they occur and not as cash or cash equivalent is received or paid, and they
are recorded and reported in the financial statements of the periods to which
they relate.

In the simplest language, accrual basis means that assets are recognized
when receivable rather than when physically received, and liabilities are,
recognized payable rather than when actually paid.

Accrual accounting means that income is recognized when earned regardless of

when received and expense is recognized when incurred regardless of when
paid.

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The essence of accrual accounting is the recognition of accounts receivable,

accounts payable, prepaid expenses, accrued expenses, deferred income, and
accrued income.

Materiality and aggregation

An entity shall present separately each material class of similar items.

An entity shall present separately items of dissimilar nature or function

unless they are immaterial.

The final stage in the process of aggregation and classification is the

presentation of condensed and classified data which form line items in the
financial statements.

For example, cash on hand, petty cash fund, cash in bank and cash equivalent
shall be presented as one item "cash and cash equivalents".

Finished goods, goods in process, raw materials and manufacturing supplies are
aggregated and presented as one item "inventories".

If a line item is not individually material , it is aggregated with other items

either in those statements or in the notes.

For example, an investor's share in the net income of an associate is presented

as a separate line statement in the income statement.

However, if this amount is not individually material, it may be aggregated with

other income.

Materiality dictates that "an entity need not provide a specific disclosure required
by PFRS if the information is not material"

When is an item material?

There is no strict or uniform rule for determining whether an item is material or

not.

Very often, this is dependent on good judgment, professional expertise and

common sense.

However, a general guide may be given, to wit:

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An item is material if knowledge of it would affect the decision of the informed

users of the financial statements.

Materiality is a relativity

Materiality of an item depends on relative size rather than absolute size.

Factors of materiality

In the exercise of judgment in determining materiality, the following factors may

be considered.

a. Relative of size of the item – in relation to the total group to which the item
belongs.

b. Nature of the item – An item may inherently material because by its very
nature it affects economic decision.

Offsetting

Assets, liabilities, and income and expenses, when material, SHALL NOT be
offset against each other.

Offsetting may be done when it is required or permitted by another PFRS.

Examples of Offsetting

Gains and losses on disposal of noncurrent assets are reported by deducting

from the proceeds the carrying amount of the assets and the related selling
expenses.

Expenditure related to a provision and reimbursed under contractual

arrangement with a third party may be netted against the related
reimbursement.

In other words, the expenditure related to a provision and any reimbursement

from a third party can be offset, and only the net expenditure is presented as
expense.

In addition, gains and losses arising from a group of similar transactions are
reported on a net basis.

For example, foreign exchange gains and losses or gains and losses arising from
trading securities are netted against the other.

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However, if material, such gains and losses are reported separately.

The measurement of assets net of valuation allowance is permitted because

technically this is not offsetting.

Thus, accounts receivable may be shown net of allowance for doubtful accounts.

Frequency of reporting

An entity shall present a complete set of financial statements at least annually.

When an entity changes the end of the reporting period and presents financial
statements for a period longer or shorter than one year, the entity shall disclose:

a. The period covered by the financial statements.

b. The reason for using a longer or shorter period.
c. The fact that amounts presented in the financial statements are not entirely
comparable.

Comparable information

Except when permitted or required otherwise by PFRS, an entity shall disclose

comparative information in respect of previous period for all amounts reported
in the current period’s financial statements.

In other words, the financial statements of the current period shall be presented
with comparative figures of the financial statements of the immediately
preceding year.

Comparative information shall be included for narrative and descriptive

information when it is relevant to an understanding of the current’s period
financial statements.

For example, details of a legal dispute, the outcome of which was uncertain at
the end of the preceding reporting period and is yet to be resolved, are disclosed
in the current period.

Users shall benefit from information that an uncertainty existed at the end of the
immediately preceding reporting period, and steps have been taken during the
current period to resolve the uncertainty.

Third statement of financial position

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A third statement of financial position is required when an entity:

a. Applies an accounting policy retrospectively.

b. Makes retrospective restatement of items in the financial statements.
c. Reclassifies items in the financial statements.

Under these circumstances, an entity shall present three statements of financial

position as at:

1. The end of the current period

2. The end of the previous period
3. The beginning of the earliest comparative period

Consistency of presentation

Implicit in the presentation of comparable information is the principle of

consistency.

The principle of consistency requires that the accounting methods and practices
shall be applied on a uniform basis from period to period .

The presentation and classification of financial statement items shall be uniform

from one accounting period to the next.

An entity cannot use the FIFO method of inventory valuation in one year, the
average method in the next year, another method in succeeding year and so on.

If the FIFO method is adopted in one year, such method is followed from year to
year.

Consistency is desirable and essential to achieve comparability of financial

statements.

However, consistency does not mean that no change in accounting method can
be made.

If the change will result to information that is faithfully represented and more
relevant to the users of financial statements, then such change should be made.

But there should be full disclosure of the change and the peso effect of the
change.

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A change in the presentation and classification of items in the financial

statements is allowed:

A change in the presentation and classification of items in the financial

statements is allowed:

a. When it is required by another PFRS.

b. When a significant change in the nature of the operations of the entity will
demonstrate a more appropriate revised presentation and classification.

It is inappropriate for an entity to leave accounting policies unchanged when

better and acceptable alternatives exist.

Identification of financial statements

Financial statements shall be clearly identified and distinguished from other

information in the same published document.

Each component of the financial statements shall be clearly.

In addition, the following information shall be prominently displayed:

a. The name of the reporting entity.

b. Whether the financial statements cover the individual entity or a group of
entities.
c. The end of the reporting period or the period covered by
d. The presentation currency.
e. The level of rounding used in the amounts in the financial statements

Financial statements are often made more understandable by presenting

information in thousands or millions of units of the presentation currency.
This is acceptable as long as the level of rounding in presentation is disclosed
and relevant and material information is not lost or omitted.

III. Assessment

In yellow paper, answer the questions BRIEFLY.

1. Define financial statements.

2. Explain general purpose financial statements.
3. What are the components of financial statements?
4. Explain the objective of financial statements.

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5. To meet the objective of financial statements, what information is necessary?

6. Explain financial position, financial performance and cash flows of an entity.
7. Explain financial reporting.
8. Explain the target users of financial reporting.
9. What is the objective of financial reporting under the Conceptual Framework
for Financial Reporting?
10. What are the specific objectives of financial reporting?
11. What are the limitations of financial reporting?
12. Explain the responsibility for the preparation and presentation of financial
statements.
13. What are the general features of financial statements?
14. Explain fair 'presentation of financial statements.
15. Specifically, what are the requirements of fair presentation?
16. Explain the requirements when there is a departure from an accounting
standard.
19. Explain materiality
20. When is an item material?
21. What are the factors in determining materiality?
22. Explain the rule on offsetting.
23. Explain the frequency of reporting financial statements.
24. What are the necessary disclosures when an entity presents financial
statements for a period longer or shorter than one year?
25. Explain the requirement for comparable information.
26. What are the circumstances when three statements of financial position are
required?
27. What is consistency of presentation?
28. When is a change in the presentation and classification
of items in the financial statements allowed?
29. What is identification of financial statements?
30. What information shall be prominently displayed in identifying financial
statements?

Deadline: October 16, 2020, Friday at 12nn. Send your assignment to the
representative of the class.

References: Financial Accounting 3 by: Valix 2019 edition

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