INTERMEDIATE ACCOUNTING Volume Three CONRADO T. VALIX, BSC, LLB * Certified Public Accountant and Lawyer President, Review Director and CPA Reviewer CPA Review School of the Philippines CPAR Lifetime Member Integrated Bar of the Philippines JOSE F. PERALTA, BBA, MBA, DBA Certified Public Accountant President and Dean Philippine School of Business Administration CHRISTIAN ARIS M. VALIX, BSME, BSA Certified Public Accountant ‘Ateneo Management Engineering Graduate Former Faculty Member, Ateneo and San Beda Assistant Review Director, CPAR CPA Reviewer, CPAR 2020 Revised EditionCopyright 2020 by Conrado T. Valix Jose F. Peralta Christian Aris M. Valix Any copy of this book not bearing the signature of one of the authors on this page is unauthorized and shall be considered as proceeding from an illegal source. . / . Me: ALL RIGHTS RESERVED ISBN: 978-621-416-091-4 Published & Printed by: GIC€ ENTERPRISES & CO., INC. | *National Book Development Board Registered 2017 C.M. Recto Avenue, Sampaloc Manila, PhilippinesPREFACE This volume is written to conform with the new undergraduate course syllabus for Intermediate Accounting Three as promulgated by the Commission on Higher Education. . This book is the culmination of the Intermediate Accounting cluster. It is designed to cover the preparation of statement of financial position, income statement, statement of comprehensive.income, statement of changes in equity, statement of cash flows, notes to financial statements, related parties and events after reporting period. The book also covers single entry, cash and accrual basis of accounting, error correction, accounting changes, noncurrent. asset held for sale, discontinued operation, interim financial reporting, segment reporting, derivatives, book value per share, earnings per share, hyperinflation and current cost accounting. In addition, the book includes the discussion and illustration of the Philippine Financial Reporting Standards for Small and Medium-sized Entities or PFRS for SMEs as compared with full PFRS. A new chapter on Small ‘Entities is added in accordance with the Philippine Financial Reporting Standards for Small Entities, Moreover, the book is prepared in conformity with amended Philippine standards, amended International Accounting Standards and current International Financial Reporting Standards or IFRS. The International Accounting Standard or IAS is now known as International Financial Reporting Standard.The Philippine standards are now known as Philippine Accounting Standards or PAS and Philippine Financial Roporting Standards or PFRS. These standards are numbered the same as their counterpart in International Accounting Standards and International Financial Reporting Standards, The following Philippine Accounting Standards and Philippine Financial Reporting Standards are extensively discussed and illustrated: PAS 1 Presentation of financial statements PAS 7 Statement of cash flows PAS § Accounting policies, changes in accounting estimates and errors PAS 10 Events after reporting period PAS 24 Related party disclosures PAS 29 Financial reporting in hyperinflationary economy PAS 383 Earnings per share : PAS 34 Interim financial reporting PAS 37 Provisions, contingent liabilities and contingent assets PFRS 5 Noncurrent assets held for sale and discontinued operations PFRS 8 Operating segments PFRS for Small and Medium-sized Entities (SMEs) PFRS for Small Entities (SEs)The problems and multiple choice questions at the end of each chapter are lifted from the following sources: PHILCPA Adapted Philippine CPA . Licensure Examinations given by the Board of Accountancy AICPA Adapted Uniform CPA Examinations given by the American Institute of Certified Public Accountants IAA Adapted problems and questions from various intermediate accounting textbooks ACP Author constructed problems and questions to exemplify Philippine standards PAS Questions based on provisions of Philippine Accounting Standards . PFRS Questions based on provisions of Philippine Financial Reporting Standards IAS Questions based on _ provisions, ‘interpretations and application guidance of. International Accounting Standards IFRS . Questions based on _ provisions, interpretations and application guidance of +: International Financial Reporting Standards VALIX PERALTA VALIX January 2020CONTENTS CHAPTER 1 FINANCIAL STATEMENTS Definition of financial statements General purpose financial statements Components of financial statements Objective of financial statements Financial reporting Objective of financial reporting Limitations of financial reporting Responsibility for financial statements General features of financial statements Identification of financial statements CHAPTER 2 32 STATEMENT OF FINANCIAL POSITION Definition of statement of financial position Definition of assets, Current assets Presentation of current assets Noncurrent assets Presentation of noncurrent assets Definition of liabilities Current liabilities Presentation of current liabilities Noncurrent liabilities Estimated liabilities . Contingent liability and contingent asset Elements of shareholders’ equity with IAS term Line items in the statement of financial position Forms of statement of financial position Illustrative statement of financial position ”CHAPTER 3 NOTES TO FINAN Related parties Events after reportin| CIAL STATEMENTS g period cial statements Definition of notes to finan 1 statements Purpose of notes to financial Order of presenting notes Compliance with PFRS Accounting policies Disclosure of measurement basis Disclosure of accounting policies Disclosure of judgment Disclosure of estimation uncertainty Other disclosures Examples of notes to financial statements Definition of related party Control, significant influence-and joint Examples of related parties Examples of related party transactions Disclosures of related party transaction Key management personnel compensation Unrelated parties Transactions with government-related entities Pricing policies . Definition Types of events after the reporting period Adjusting events Nonadjusting events Financial statements authorized for issue t control 88 }CHAPTER 4 136 STATEMENT OF COMPREHENSIVE INCOME Definition of comprehensive income Components of comprehensive income Definition of profit or loss Definition of other comprehensive income Presentation of other comprehensive income Separate income statement Line items in the statement of comprehensive income Forms of income statement Single statement of comprehensive income CHAPTER 5 161 STATEMENT OF CHANGES IN EQUITY Definition of statement of changes in equity Presentation of statement of changes in equity Statement of retained earnings Items directly affecting retained earnings CHAPTER 6 174 NONCURRENT ASSET HELD FOR SALE Definition Conditions for classification as held for sale ! Measurement and presentation of asset held for sale Writedown to fair value and reversal of writedown Revalued asset classified as held for sale Abandoned noncurrent asset Temporarily abandoned noncurrent asset Change in classification of noncurrent asset held for sale Change in method of disposalCHAPTER 7 DISCONTINUED OPERATION Definition of discontinued operation Component of an entity Component classified as held for sale Timing of reporting . Presentation of discontinued operation Abandoned discontinued operation CHAPTER 8 216 ACCOUNTING CHANGES Change in accounting estimate Definition of accounting changes Change in accounting estimate CHAPTER 9 230 ACCOUNTING CHANGES Change in accounting policy Prior period errors Definition of accounting policy Requirement for change in accounting policy Change in reporting entity Absence of accounting standard Treatment of prior period errorsCHAPTER 10 255 INTERIM FINANCIAL REPORTING Definition of interim financial reporting Frequency of interim reporting ‘Two views on interim financial reporting Components of interim financial report Selected explanatory notes Presentation of interim financial statements Basic principles for interim financial reporting CHAPTER 11 285 OPERATING SEGMENT Core principle of segment reporting Definition of operating segment Chief operating decision maker Management approach of identifying gperating segment Reportable operating segment Aggregation of operating segments Jmformation to be disclosed for each segment Disclosure about general information Disclosure of profit or loss, segment assets , and segment liabilities Reconciliations of segment information Entity-wide disclosures Revenue from products and services Information about geographical areas Information about major customerswo 1 w CHAPTER 12 DERIVATIVES Interest rate swap Purpose of derivatives Types of financial risk Definition of derivative Characteristics of derivative Measurement of derivative No hedging designation Fair value hedge Cash flow hedge Interest rate swap CHAPTER 13 350 DERIVATIVES Forward, futures and option Forward contract Futures contract Call option and put option Embedded derivative CHAPTER 14 875 CASH AND ACCRUAL BASIS Cash basis versus accrual basis Adjustment of cash basis statements to accrual basis statements Computation of sales Computation of purchases Computation of income other than sales Computation of expensesCHAPTER 15 416 SINGLE ENTRY Characteristics of single entry Single entry method of determining net income or loss Preparation of financial statements from single entry records CHAPTER 16 449 ERROR CORRECTION Prior period errors Trestment of prior period errors Statement of financial position errors Income statement errors Counterbalancing errors Noncounterbalancing errors Worksheet for correction of errors CHAPTER 17 486 STATEMENT OF CASH FLOWS Definition of statement of cash flows Primary purpose of statement of cash flows Cash and cash equivalents Operating activities Investing activities Financing activities Noncash transactions Direct and indirect methodCHAPTER 18 “BOOK VALUE PER SHARE Definition of book value per share Liquidation value of preference share Preference as to assets Preference as to dividends Cumulative preference share Noncumulative preference share Participating preference share Nonparticipating preference share CHAPTER 19 BASIC EARNINGS PER SHARE Definition of earnings per share Uses of earnings per share Presentation of earnings per share Ordinary share Basic earnings per share Average shares outstanding Participating preference share Bonus issue Rights issue Basic loss per share CHAPTER 20 DILUTED EARNINGS PER SHARE Potential ordinary share Dilution and antidilution Diluted earnings per share Convertible bond payable Convertible preference share Options and warrants Treasury share method Diluted loss per share 548 582 614CHAPTER 21 647 DILUTED EARNINGS PER SHARE Multiple potential ordinary shares Test for dilution Ranking of potential ordinary shares Written put options - Contingent ordinary shares Convertible bonds payable settled in shares or cash CHAPTER 22 671 HYPERINFLATION Definition of hyperinflation General price index Specific price index Financial reporting in a hyperinflationary economy Constant peso ‘accounting Monetary and nonmonetary items Gain or loss on purchasing power Procedures for restatement . Economy ceasing to be hyperinflationary Disclosures required for hyperinflationCHAPTER 23 CURRENT COST ACCOUNTING Definition of current cost Unrealized holding gain or loss Realized holding gain or loss Preparation of current cost incom‘ Preparation of current cost statement of financial position e statement CHAPTER 24 SMEs - DEFINITION Definition of SMEs Public accountability SME under Philippine jurisdiction Micro-business entities Exemptions from PFRS for SMEs Transition to PFRS for SMEs Date of transition Opening statement of financial position Reconciliation of PFRS for SMEs and previous accounting frameworkCHAPTER 25 740 SMEs - FINANCIAL STATEMENTS Definition of financial statements General features of financial statements Components of financial statements Statement of financial position Single statement of income and retained earnings Definition of comprehensive income Profit or loss .Other comprehensive income Statement of comprehensive income Notes to financial statements Definition of notes to financial statements Structure of notes Order of presenting notes Related parties Related party disclosures * Definition of related parties Definition of unrelated parties Events after the reporting period Accounting changes Accounting policies Accounting estimate. Prior period errors765 CHAPTER 26 SMEs ~ ASSETS Inventories Definition of inventories Measurement of inventories Basic financial instruments Definition of basic financial instruments Conditions for basic financial instruments _ Financial instruments not qualifying as basic financial, instruments Initial and subsequent measurement of basic financial instruments Investment in associate Definition of associate Measurement of investment in associate Cost model ‘ Equity method Fair value model Financial statement presentation Investment property Definition of investment property Examples of investment property Initial and subsequent measurement of, investment property Transfer of investment propertyCHAPTER 27 792 SMEs - ASSETS Property, plant and equipment Definition of property, plant and equipment Initial measurement of property, plant and equipment Subsequent measurement of property, plant and equipment Government grant Definition of government grant Recognition of government grant Measurement of government grant Borrowing costs Definition of borrowing costs Recognition of borrowing costs Intangible asset Definition of intangible asset Recognition of intangible asset Initial measurement of intangible asset Subsequent measurement of intangible asset Impairment of asset General principle on impairment Fair value less cost of disposal Value in use Recoverable amount8 CHAPTER 28 a SMEs ~ LIABILITIES Provision and contingencies Definition of provision Recognition of provision Measurement of provision Contingent liability Contingent asset Leases Definition lease Leases outside the scope of PFRS for SMEs Finance lease and operating lease Employee benefits Definition of employee benefits Short-term employee benefits Defined contribution plan Defined benefit plan Other long-term employee benefits Termination benefits 7 Income tax Definition of income tax Current tax asset and liability Deferred tax asset and liability Recognition and measurement of defered tax asset ¢ Recognition and measurement of deferred tax liability Allocation of tax expense Offsetting of tax asset and tax liabilityCHAPTER 29 aaa SMEs - EQUITY Definition of equity Measurement of equity shares Recognition of original issue of shares Share-based payment Share-based payment transaction Equity settled transaction Cash settled transaction Share options Share appreciation right Share-based transaction with cash alternative | Agriculture Definition of agriculture Definition of biological asset Definition of agricultural produce Measurement of biological asset Measurement of agricultural produce Other specialized activities Exploration and evaluation of mineral resources Exploration and evaluation asset Service concession Infrastructure asset as fin’..cial asset Infrastructure asset as ir. angible asset ‘Hyperinflation Definition of hyperinflation . Indicator of hyperinflationary economyCHAPTER 30 SMALL ENTITIES Definition of small entities ai Exemptions from PFRS for Small Entities Financial statements of small entity . Basic financial instruments of small entity Measurement of inventories . Measurement of investment in associate Measurement of investment property . Measurement of property, plant and equipment Monetary and nonmonetary grant Recognition of borrowing costs Measurement of intangible asset Impairment of asset Measurement of biological asset and agricultural produce Recognition of provision and contingent liability Recognition of lease Recognition of income tax Reccognition of employee benefit ‘easurement of equity settled share-based payment transaction Measurement of cash settled share-based Payment transaction Transition to PFRS for Small Entities Reconciliations of Previous accountin, fr: and PFRS for Small Entities ©" *™eWork 855CHAPTER 1 FINANCIAL STATEMENTS TECHNICAL KNOWLEDGE 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 statements.FINANCIAL STATEMENTS i informati Financial statements are the means by which the ™ for Hee accumulated and processed in financ’ periodically communicated to the users. a structured financial] : i are i Financial statements ial position and financial ,representation of the finance 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 of an entity's management or bankers are not general purpose financial statements decause they are prepared specifically to meet the needs of management or bankers. ‘ Components of financial statements A complete set of financial statements comprises the following components: Statement of financial position Income statement Statement of comprehensive income Statement of changes in equity Statement of cash flows Notes, comprising a summary of significant accounting policies and other explanatory information PAP OP pe _ Many entities also present reports and statements such as environmental reports and value added statements, Particularly in industries in which environmental factors are significant and when employees are regard: i oor group. garded as an important However, such statements and re 0: of financial statements. Ports are not componentsFINANCIAL STATEMENTS Financial statements are the means by whic the information accumulated and processed in financta! ac ng is Periodically communicated to the users. Financial statements are a structured financial .Yepresentation 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 of an entity's management or bankers are not general purpose financial statements yecause they are prepared specifically to meet the needs of management or bankers. ‘ Components of financial statements A complete set of financial statements comprises the following components: Statement of financial position Income statement Statement of comprehensive income Statement of changes in equity Statement of cash flows Notes, comprising a summary of significant accounting policies and other explanatory information PoP er Many entities also present reports and statements such aS environmental reports and value added statements, particularly in industries in which environmental factors are significant and when employees are regarded as an important user group. However, such statements and reports are not components of financial statements. :Objective of financial statements 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” Z 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, nai 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. 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 flows Cash flows are ‘the cash receipts and cash payments arising from the operating, investing and financing activities of the eritity. 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 about an entity to external users that is useful to them in making economic decisions and for assessing the effectiveness of the entity's management. ‘The principal way of providing financial information to external users is through the annual financial statements. However, financial reporting encompasses not only financial statements but also other means of communicating information that relates directly or indirectly to the financial accounting process. 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 Revised 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 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, Loe 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 Revised 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. ¢. To provide information about entity resources, claims and changes in resources and claims.Limitations of financial reporting a, General purpose financial reports do not and cannot provide all of the 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 usera estimate the value of the entity. . General purpose financial reports are intended to provide common information to users and cannot accommodate every specific request for information. oe) d. Toa large extent, financial reports are based on estimate and judgment rather than exact depiction. Responsibility for financial statements The management of an entity has the primary responsibility for the preparation and presentation of financial statements. The Board of Directors in discharging its responsibilities reviews and authorizes the financial statements for issue before these are submitted:to the shareholders of the entity. Management is accountable for the safekeeping of the resources and their proper, efficient and profitable use. Shareholders are interested in information that helps them assess how effectively management has fulfilled this role as this is relevant to the decision concerning ‘their investment and the reappointment or replacement of management. General features of financial statements . Fair presentation and compliance with PFRS Going concern . Accrual basis . Materiality and aggregation . Offsetting . Frequency of reporting . Comparative information . Consistency of presentation WAMMAAR we 7Fair presentation The financial statements shall present farly oe 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 aid unreserved statement of such compliance in the notes. 7 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. 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 vectify 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 the relevant regulatory Conceptual Framework requires, or otherwise does not prohibit, such a departure. Thus, an’‘entity is permitted to depart from a standard: a. In extremely rare circumstances. b.: When management concludes that compliance with the standard would be misleading. c. When the departure from the standard is necessary to achieve fair presentation. * d. 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, the nature of the departure, including the treatment that 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.Going concern a 7 ity is viewed as Going concern means that the accounting oe dn of evidence continuing ir. operation indefinitely in to the contrary. inui tion. Going concern is also known as continuity assump! are prepared normally i ts . 7 In other words, financial statemen continue in operation on the assumption that the entity shal 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. This postulate is the very foundation of the cost principle. Financial statements shall be prepared on a going concern basis unless management intends to liquidate the entity or cease trading or has no realistic option but to do so. When upon assessment it becomes evident that there are material uncertainties regarding the ability of the entity to continue as a going concern, those uncertainties shall be fully disclosed. in making the assessment about the going concern assumption, management shall take into account all available information about the future which is at least twelve months from the end of reporting period. 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. 10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. 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. Financial statements result from processing large number of transactions or other events that are aggregated into classes according to their nature or function. ‘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”. 11material, it is aggregated If a line item is not individually ents or in the notes, with other items either in those statem' are in the net income of an x: i ris sh i : For example, an investor's @ item in the income associate is presented as a separate lin 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: An item is material if knowledge of it would affect the decision of the primary users of the financial statements. For example, small expenditures for tools are often expensed immediately rather than depreciated over their useful life to save on clerical costs of recording depreciation. In such a case, the effect on the financial statements is not . large enough to affect economic decision. Another example is the common practice of large entities of rounding amounts to the nearest thousand pesos in their financial statements. Small entities may round off to the nearest peso. 12New definition of materiality The IASB provided: the following new definition of materiality. Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the economic decisions that primary users of general purpose financial statements niake on the basis of those statements which provide financial information about a specific reporting entity. In other words, an information is material if the omission, ‘misstatement and obscuring of the information could reasonably affect the econome decision of primary users. The revised definition of materiality highlights three important aspects: a. Could reasonably be expected to influence b. Obscuring information c. Primary users Could reasonably be expected to influence The could reasonably be expected to influence threshold adds an element of reasonability of financial information on which economic decision is based. By including the term could reasonably be expected to influence in the new definition, material information shall be limited to the economic: decision of primary users rather than to all users which is too broad in scope. « Moreover, the could reasonably be expected to influence, threshold insures that information capable of influencing economic decision of the primary users shall be included in the financial statements. 13Obscuring information Obscuring information is a new concept added to the new definition of materiality. if presenting or communicating it Information is obscured ng ' - would have a similar effect as omitting or misstating: the information. Obscuring information means the presentation of financial information not readily understood or not clearly expressed. ” Obscuring information may be characterized by deliberate vagueness, ambiguity and abstruseness. Examples of obscured material information are: a. The language is vague or unclear. i . b. The information is scattered throughout the financial statements. c. Dissimilar items are aggregated inappropriately. d. Similar items are disaggregated inappropirately. Primary users The new definition of materiality narrows the definition to primary users who are primarily affected by general purpose financial statements. The primary users include the existing and potential investors, lenders and other creditors. , The other users include the employees, customers, government agencies and the public in general. The new definition specified that only primary users of financial statements are considered because these groups are the users to whom general purpose financial statements are primarily directed. Such primary users cannot require reporting entities to provide information directly to them and therefore must rely on general purpose financial reports for how much financial information is needed.Materiality is a relativity Materiality of an item depends on relative size rather than absolute size. What is material for one entity may be immaterial for another. An error of P100,000 in the financial statements of a multinational entity may not be important but may be so critical for a small entity. Factors of materiality In the exercise of judgment in determining materiality, the following factors may be considered: a. Relative size of the item in relation to the total of the group to which the item belongs. For example, the amount of advertising in relation to total distribution costs, the amount of office salaries to total administrative expenses, the amount of prepaid expenses to total current assets and the amount of leasehold improvements to total property, plant and equipment. b. Nature of the item — An item may be inherently material because by its very nature it affects economic decision. For example, the discovery of a P20,000 bribe is a material event even for a very large entity. Offsetting ‘Assets and 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. 15Examples of offsetting f noncurrent assets are i isposal 0: i Gains and losses on disp’ arrying amount reported by deducting from the proceeds the 7 of the assets and the related selling expenses- Expenditure related. to a provision and reimbursed ae a 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 avising 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. 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: The period covered by the financial statements, The reason for using a longer or shorter period. c. The fact that amounts presented in the financial statements are not entirely comparable. 16Comparable information Except when permitted or required otherwise by standard, an entity shall disclose comparative information in respect of the 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 period's 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 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 8. The beginning of the earliest comparative period 17Consistency of presentation 7 . le Implicit in the presentation of comparab! principle of consistency. The principle of consistency reque methods and practices shall be app from period to period. information is the that the accounting lied ‘on a uniform basis of financial statement The presentation and classification unting period to the items shall be uniform. from one acc’ next. thod of inventory valuation An entity cannot use the FIFO me et year, another in one year, the average method in the ne: 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. A change in the presentation and classification of items ii the financial statements is allowed: vor se a. When it is required by another Standard. b. When a significant change in the nat) of thé entity will demonstrate a mor presentation and classification. ‘ure of the operations ‘€ appropriate revised It is inappropriate for an entity to leav. i y e acco’ ici unchanged when better and acceptable alternative, ieee 18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 identified. 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 the financial statements or notes. 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. . 19QUESTIONS 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. 5. To meet the objective of financial statements, what information is necessary? 6. Explain financial position, financial performance and cash flows of an entity. ma Explain financial reporting. @ 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. 20ea 17, Explain going concern. 18. Explain accrual basis af accounting. 19. Explain materiality and aggregation. 1 20. What is the new definition of materiality? 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 Laniaie 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? 21PROBLEMS Problem 1-1 Multiple choice (PAS 1) ae f 1. A complete set of financial statements includes all of the following components, except a. Statement of financial position b. Statement of changes in equity ¢. Notes to financial statements d. Environmental reports and value added statements bo What is the objective of financial statements? a. To provide information about the financial position, financial performance and changes in financia position useful to a wide range of users b. To prepare a statement of financial position and statement of comprehensive income c. To present relevant, reliable, comparable and understandable information : d. To prepare financial statements in accordance with all applicable standards ~@ . The primary responsibility for the preparation of the financial statements is reposed in a. Management of the entity b. Internal auditor c. External auditor d. Controller > . The major financial statements include all, except a. Statement of financial position b. Income statement c. Statement of cash flows d. Statement of retained earnings a . The major financial statements include all, except a. Statement of financial position b. Statement of-changes in financial Position c. Statement of comprehensive income d. Statement of changes in equity 22Problem 1-2 Multiple choice (IFRS) 1, When an entity changed the reporting period longer or shorter than one year, an entity shall disclose all of the following, except a. 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. d. The fact that similar entities in the geographical area in which the entity operates have done so. pe Which of the following is not a component of the financial statements? a. Statement of financial position b.. Statement of changes in equity c. Report of board of directors d. Notes to financial statements e Which of the following is included in a complete.set of financial statements? a. A statement by the board of directors of compliance with local legislation b. A statement of changes in equity c. Statements of financial position for the last five years d. Value added statement Which of the following is included within the financial statements? a. A statement of retained earnings b. Accounting policies ce. An auditor's report d. Board of directors’ report a a An entity shall clearly identify each financial statement, and display all of the following, except Name of the reporting entity. Names of major shareholders of the entity. The presentation currency. Whether the financial statements cover the individual entity or a group of entities. Boop 23Problem 1-3 Multiple choice (PAS 1) 1.Which statement is incorrect conc erning fair Presentation of financial statements? a. b. Fair. presentation requires the faithful representation of the effects of transactions and other events. ' Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. — In virtually all circumstances, a fair presentation is achieved by compliance with applicable PERS. . An entity whose financial statements comply with PFRS shall not make an explicit and unreserved statement of such compliance in notes. 2. Which of the following cannot be considered fair presentation of financial statements? a. To present information in a manner that provides relevant and faithfully represented financial information.- To provide additional disclosures when compliance with specific PFRS is insufficient to understand the financial position and financial performance. To select and apply accounting policies in accordance with applicable PFRS. : To rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory information. 3. Which statement indicates a going concern? Management intends to liquidate the entity. Management intends to cease the operations of the entity. Management has no realistic alternative but to cease the operations of the entity. . None of these would indicate going concern 244. An entity is permitted to depart from a particular on 6. y standard if all of the following conditions are satisfied, except a. In extremely rare circumstances. b. When management concludes that compliance with the standard would be misleading. c. When the departure from the standard is necessary to achieve fair presentation. d, When the Conceptual Framework for Financial Reporting prohibits such a departure. . The effects of transactions and other events on economic resources and claims are depicted in the periods in which those effects occur even if the resulting cash receipts and payments occur in a different period. . Accrual accounting Cash accounting Modified accrual accounting Modified cash accounting aeop Financial statements must be prepared at least Annually . Quarterly Semiannually . Every two years peop Technically, offsetting in financial statements is accomplished when a. The allowance for doubtful accounts is deducted from accounts receivable. b. The accumulated depreciation is deducted from property, plant and equipment. The total liabilities are deducted from total assets. d. Gain or loss from disposal of noncurrent asset is reported by deducting from the proceeds the carrying amount of the asset and the related disposal cost. f 258. 10. ificati i s in t! The presentation and classification aa financial statements shall be retaine period to the next. Consistency of presentation Materiality Aggregation Comparability RO Tp . A third statement of financial position as at beginning of the earliest comparative period presented is required a. When an entity applies an accounting policy retrospectively. b. When an entity makes a retrospective restatement of items in the financial statements. : c. When an entity reclassifies items in the financial statements. d. Under all of these circumstances Which statement in relation to financial statements in incorrect? a. General purpose financial statements do not and cannot provide all of thé information that primary users need. b. General purpose financial statements are designed to show the value of the reporting entity. c, General purpose financial statements are intended to provide common information to ‘users. d. Financial statements are largely based on estimate and judgment rather than exact depiction. 26Problem 1-4 Multiple choice (IFRS) 1. Items of dissimilar nature or function 2. Materiality depends on a. Must always be presented separately. b. Must not be presented separately. c. Must be presented separately if material. d. Must be presented separately even if immaterial. a. The nature of the omission, misstatement or obscured information. b. The absolute size of the omission or misstatement. c. The relative size and nature of the omission, misstatement or obscured information. d. The judgment of management. 3.An entity must disclose comparative information for a. The previous comparable period for all amounts. b. The previous comparable period for all amounts and for all narrative and descriptive information. c. The previous comparable period for all amounts and for all narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. d. The previous two comparable periods for all amounts. 4, When the classification of items in the financial ’ statements is changed, the entity a. Must not reclassifiy the comparative amounts. b.. Can choose whether or not to reclassify. c. Must reclassify the comparative amounts unless it-is impracticable to do so. d. Must reclassify the current year amounts only. 5. An entity shall present a. The statement of cash flows more prominently. b. The statement of financial position more prominently. c. The income statement more prominently. d. Each financial statement with equal prominence. . 27Problem 1-5 Multiple choice (AA) 1 The overall objective of financial reporting is to Provide information ‘That is useful for decision making About assets, liabilities and equity ‘od About financial performance during a perio! That assesses performance of management pe op . The objective of financial reporting is based on a. The need for conservatism . b. Reporting on management stewardship c. Generally accepted accounting principles d. The needs of the users of the information . The primary focus of financial reporting has been on meeting the needs of which of the following groups? a. Management b. Existing and’ potential investors, lenders and other creditors c. National taxing authorities d. Independent CPAs The primary objective of financial reporting is to provide useful information to’ a. Management b. Capital providers c. Regulatory body d. Government Which is an objective of financial reporting? ‘ a. To provide information that is useful in making investing and credit decisions. To provide information that is useful’ to management. To provide information to investors. To provide information about internal and external conflicts, Bes 286. Which is an objective of financial reporting? a. To provide information useful to management. b. To identify nonfinancial transactions, c. To provide information useful to assess the amount, timing and uncertainty of prospective cash receipts. dy’ To provide information that excludes claims. 7. An objective of financial reporting is to provide Information about the investors in the entity. Information about the liquidation value of the entity. Information useful ‘in assessing cash flow prospects. Information that will attract new investors. Bore 8. Assessing cash flow prospects is intérpreted to mean a. Cash basis accounting is preferred over accrual basis. b. Information about the financial effects of cash receipts and cash payments is generally considered the best indicator of ability to generate favorable cash flows. c. Over the long run, trends in revenue and expenses are generally more meaningful than trends in cash receipts and disbursements. d. Allof the choices are correct regarding assessing cash flow prospects. 29; : A Adapted) Problem 1-6 Multiple choice arcr Ls direction of 1. During a period when an entity 16 oP ne vrting will a particular management, financi® directly provide information about ; a. Entity performance and management ee javformanes b. Management performance but not ement performance c. Entity performance but not managem ce d. Neither entity nor management performan 2. Financial reporting pertains to a. Individual business entities, rather than to industries or an economy or to members of society as consumers b. Individual business entities and an economy or to members of society as consumers c. Individual business entities and an economy rather than to industries or to consumers | d. Individual business entities, industries and an economy rather than to members of society as consumers 8. Which is not an objective of financial reporting? a. Financial reporting shall provide information about resources, claims against resources and changes in them. 7 b. Financial reporting shall provide information useful in evaluating stewardship of management. c. Financial reporting shall provide information useful in investment, credit and similar decision. d. Financial reporting shall provide information useful in assessing cash flow prospects. 4, Which is not an objective of financial reporting? a. To provide information about assets and claims against those assets b. To provide information useful in assessing cash flows To provide information useful in lending and investing decisions d. To provide information about the liquidation value of an entity ° 80Problem 1-7 Multiple choice (IAA) L pe ~ fat a Which would likely prepare the most accurate financial forecast for an entity based on empirical evidence? Investors using statistical models Corporate management Financial analysts . Independent certified public accountants Bes What is the most useful information in predicting future cash flows? a. Information about current cash flows b. Current earnings based on accrual accounting c. Information regarding the accounting policies used d. Information regarding the results obtained by using a wide variety of accounting policies . The accrual basis of accounting is most useful for Determining the amount of income tax liability. Predicting short-term financial performance. Predicting long-term financial performance. Determining the amount of dividends to shareholders. peop In measuring financial performance, accrual accounting is used because : i a. Cash flows are considered less important. b. It provides a better indication of ability to generate cash flows than cash basis. It recognizes revenue when cash is received and expenses when cash is paid. d.. It is one of the implicit assumptions. c The financial statements prepared under GAAP Do not articulate with one another. Reflect a single measurement which is historical cost. oP must be made. oe d. Contain a limited number of future projections. : 31 Ave not highly precise because estimate and judgment