Grey rers ners ~ FRAMEWORK ®& ACCOUNTING STANDARDS vs OW, 0) EDITION | Ea 2 at aan FINANCIAL REPORTING STANDARDS(PFRSs) ‘ } ( | i | ZEUS VERNON BusMbbiANCONCEPTUAL FRAMEWORK & ACCOUNTING STANDARDS 2020 Edition BASED ON CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING and PHILIPPINE FINANCIAL REPORTING STANDARDS (PERSs) Nation’s Foremost CPA Review Inc. (NCPAR) 4F Pelizloy Centrum, Lower Session Road, Baguio City 2600, Philippines Mobile Number: (0917) 870 6962 Ook Nation's Foremost CPARThis book is intended for students taking up the CHED- required subject “Conceptual Framework and Accounting Standards." The Philippine Financial Reporting Standards (PFRSs) are highly technical. My aim in writing this book is to present | concepts in a manner that would make sense to all learners - CPA aspirants and non-CPA aspirants alike. As a future CPA, you need knowledge of PFRSs because you will be directly applying them | later on. As a future business professional, you also need knowledge of PFRSs because financial reporting standards are relevant to almost all accounting-related jobs. If you are aspiring to become a future business manager, the financial statements, which are the subject matter of the PFRSs, are your responsibility. The PERSs are voluminous. Accordingly, I have discussed only the most important concepts in the PFRSs. I have omitted journal entries - these are illustrated in higher accounting subjects. Moreover, this book is designed for a three-unit subject. As with all the books that I have written and co-written so far, this book is also a labor of love and it is dedicated to you, my dear reader. If later on you have queries, comments, or suggestions on how I can improve my work, I would be glad if you inform me. Here are my contact details: [email protected] and (0917) 870 6962. Good luck in your learning and best wishes in your journey through life......thank you for making me a part of it. Sincerely, Zeus vernon B. MillanDedicatiow To all my readers - you are the reason why I write. About the Author The author is a 6” Placer in the October 2006 CPA board examinations. He is a co-founder of, and a CPA reviewer at, Nation’s Foremost CPA Review Inc. (NCPAR), a teacher, a father, a bass player and an entrepreneur.CONTENTS AT A GLANCE OVERVIEW OF ACCOUNTING CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING... PAS 1 PRESENTATION OF FINANCIAL STATEMENTS... PAS 2 INVENTORIES.......... PAS 7 STATEMENT OF CASH FLOWS. ...e-...- PAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS... 184 PAS 10 EVENTS AFTER THE REPORTING PERIOD. PAS 12 INCOME TAXES PAS 16 PROPERTY, PLANT AND EQUIPMENT. PAS 19 EMPLOYEE BENEFITS... PAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT ASSISTANCE .......... vee. 262 PAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES PAS 23 BORROWING COSTS. PAS 24 RELATED PARTY DISCLOSURES | PAS 26 ACCOUNTING AND REPORTING BY RETIREMENT BENEFIT PLANS . 300 PAS 27 SEPARATE FINANCIAL STATEMENTS PAS 28 INVESTMENTS IN ASSOCIATES AND JOINT VENTURES .. PAS 29 FINANCIAL REPORTING IN HYPERINFLATIONARY ECONOMIES. PAS 32 FINANCIAL INSTRUMENTS: PRESENTATION ........ PAS 33 EARNINGS PER SHARE... PAS 34 INTERIM FINANCIAL REPORTING ... PAS 36 IMPAIRMENT OF ASSETS... PAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS PAS 38 INTANGIBLE ASSETS ....)PAS 40 INVESTMENT PROPERTY ai — 423 PAS 41 AGRICULTURE. a isbn ase SR sinncbisieinis AAQ PFRS 1 FIRST-TIME ADOPTION OF PHILIPPINE FINANCIAL REPORTING STANDARDS... Ge 1 as E RH SISTED 453 PFRS 2 SHARE-BASED PAYMENT ..ossssssssssusssesessrsessssessenesreccsesseueveseeenes 473 PFRS 3 BUSINESS COMBINATIONS... 490 PFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS .. 502 PFRS 6 EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES ..515 PERS 7 FINANCIAL INSTRUMENTS: DISCLOSURES 521 PFRS 8 OPERATING SEGMENTS. a. 529 PFRS 9 FINANCIAL INSTRUMENTS..... 540 PFRS 10 CONSOLIDATED FINANCIAL STATEMENTS .. PFRS 11 JOINT ARRANGEMENTS... PFRS 12 DISCLOSURE OF INTERESTS IN OTHER ENTITIES. PFRS 13 FAIR VALUE MEASUREMENT PFRS 14 REGULATORY DEFERRAL ACCOUNTS... PFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS .. PFRS 16 LEASES .. PFRS 17 INSURANCE CONTRACTS .. REFERENCE..vii TABLE OF CONTENTS OVERVIEW OF ACCOUNTING. DEFINITION OF ACCOUNTING ... BASIC PURPOSE OF ACCOUNTING ACCOUNTING CONCEPTS... COMMON BRANCHES OF ACCOUNTING .. BOOKKEEPING AND ACCOUNTING. . ACCOUNTANCY... FOUR SECTORS IN THE PRACTICE OF ACCOUNTANCY... ACCOUNTING STANDARDS .... Hierarchy of Reporting Standards .... Accounting standard setting bodies and other relevant organizations .... International Accounting Standards..... OTHER RELEVANT INTERNATIONAL ORGANIZATIONS . Move T0 IFRSS CHANGES IN REPORTING STANDARDS .. SUMMARY: .. CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING .... PURPOSE OF THE CONCEPTUAL FRAMEWORK. STATUS OF THE CONCEPTUAL FRAMEWORK SCOPE OF THE CONCEPTUAL FRAMEWORK THE OBJECTIVE OF FINANCIAL REPORTING... Primary users... Decisions about providing resources to the entity QUALITATIVE CHARACTERISTICS... Fundamental qualitative characteristics . Enhancing qualitative characteristics ... The Cost Constraint ..... FINANCIAL STATEMENTS AND THE REPORTING ENTITY Reporting period.. Going concern assumption The reporting entity. THE ELEMENTS OF FINANCIAL STATEMENTS...viii Expenses RECOGNITION AND DERECOGNITION The recognition process. Recognition criteria. Derecognition .. Unit of account MEASUREMENT...... Measurement bases... Considerations when selecting a mensirement basi Measurement of equity..... Cash-flow-based measurement techniques PRESENTATION AND DISCLOSURE... Presentation and disclosure as communication tools Presentation and disclosure objectives and principles Classification . CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE Capital maintenance adjustments. Summary: PAS 1 PRESENTATION OF FINANCIAL STATEMENTS ..... FINANCIAL STATEMENTS... COMPLETE SET OF FINANCIAL STATEMENT: GENERAL FEATURES OF FINANCIAL STATEMENTS. Additional Statement of financial position STRUCTURE AND CONTENT OF FINANCIAL STATEMENTS, ‘STATEMENT OF FINANCIAL POSITION... Presentation of statement of financial position. Current assets and Current liabilities Refinancing agreement Liabilities payable on demand. STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME... 127 Profit or loss... Other Comprehensive Income (oc! Total Comprehensive Income.‘STATEMENT OF CHANGES IN EQUITY NOTES........ SUMMARY: ... PAS 2 INVENTORIES... INVENTORIES...... MEASUREMENT Cost FORMULAS, NET REALIZABLE VALUE (NRV) .. RECOGNITION AS AN EXPENSE ..... Discosures. SUMMARY: PAS 7 STATEMENT OF CASH FLOWS .. CLASSIFICATION OF CASH FLOWS... PRESENTATION .. DISCLOSURE... ‘SUMMARY: ... PAS 8 ACCOUNTING POLICIES, CHANGES IN ACCOUNTING ESTIMATES AND ERRORS... 184 184 187 189 e191 195 196 ACCOUNTING POLICIES CHANGES IN ACCOUNTING ESTIMATES. PAS 10 EVENTS AFTER THE REPORTING PERIOD ..... ADJUSTING EVENTS AFTER THE REPORTING PERIOD .... NON-ADJUSTING EVENTS AFTER THE REPORTING PERIOD .. PAS 12 INCOME TAXES... ACCOUNTING PROFIT AND TAXABLE PROFIT .. ACCOUNTING FOR DEFERRED TAXES. ACCOUNTING FOR CURRENT TAXES SUMMARY: .. PAS 16 PROPERTY, PLANT AND EQUIPMENT... RECOGNITION...... INITIAL MEASUREMENT oss sssSubsequent expenditures on recognized PPE ‘SUBSEQUENT MEASUREMENT... DERECOGNITION DISCLOSURE PAS 19 EMPLOYEE BENEFITS .... SHORT-TERM EMPLOYEE BENEFITS POsT-EMPLOYMENT BENEFITS Defined contribution plans. Defined benefit plans... . OTHER LONG-TERM EMPLOYEE BENEFIT: ‘TERMINATION BENEFITS .. SUMMARY: .. PAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT ASSISTANCE ... ACCOUNTING FOR GOVERNMENT GRANTS. i PAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES273 FUNCTIONAL CURRENCY .. FOREIGN CURRENCY TRANSACTIONS Exchange Differences................ Translation of Financial Statements .. FOREIGN OPERATION .... PAS 23 BORROWING COSTS... CAPITALIZATION OF BORROWING COSTS... SPECIFIC BORROWING... GENERAL BORROWING... PAS 24 RELATED PARTY DISCLOSURES .. RELATED PARTIES ... DISCLOSURE... DEFINED CONTRIBUTION PLANS . DEFINED BENEFIT PLANS,PREPARATION OF SEPARATE FINANCIAL STATEMENTS ... PAS 28 INVESTMENTS IN ASSOCIATES AND JOINT VENTURES ......310 INVESTMENT IN ASSOCIATE....... APPLICATION OF THE EQUITY METHOD INVESTMENT IN JOINT VENTURE . SUMMARY: .. PAS 29 FINANCIAL REPORTING ECONOMIES.. CORE PRINCIPLE....... sass RESTATEMENT OF FINANCIAL STATEMENTS .. PAS 32 FINANCIAL INSTRUMENTS: PRESENTATION.. FINANCIAL INSTRUMENTS PRESENTATION ........ COMPOUND FINANCI TREASURY SHARES... a INTEREST, DIVIDENDS, LOSSES AND GAINS .. OFFSETTING A FINANCIAL ASSET AND A FINANCIAL LIABILITY... SUMMARY: PAS 33 EARNINGS PER SHARE .. BASIC EARNINGS PER SHARE DILUTED EARNINGS PER SHARE. PRESENTATION SUMMARY: PAS 34 INTERIM FINANCIAL REPORTING . PERIODS FOR WHICH INTERIM FINANCIAL STATEMENTS ARE PRESENTED..... 367 RECOGNITION AND MEASUREMENT .. PAS 36 IMPAIRMENT OF ASSETS.. CORE PRINCIPLE .. IDENTIFYING AN ASSET THAT MAY BE IMPAIRED ... MEASURING RECOVERABLE AMOUNT... RECOGNIZING AND MEASURING AN IMPAIRMENT LOSS .... INSTRUMENTS... PAS 27 SEPARATE FINANCIAL STATEMENT: latina eaten adxii CASH-GENERATING UNITS AND GOODWILL REVERSAL OF IMPAIRMENT LOSS . SUMMARY: . PAS 37 PROVISIONS, CONTINGENT LIABILITIES AND CONTINGENT ASSETS.... PROVISIONS .... CONTINGENT LIABILITIE: CONTINGENT ASSETS ... MEASUREMENT... RESTRUCTURING .. Disclosure PAS 38 INTANGIBLE ASSETS... 397 402 INTANGIBLE ASSET. 404 RECOGNITION... 407 INITIAL MEASUREMENT 407 | Subsequent expenditures 412 | ‘SUBSEQUENT MEASUREMENT. Amortization IMPAIRMENT... DERECOGNITION .. Discosure .. SUMMARY: .. PAS 40 INVESTMENT PROPERTY .... | | | INITIAL MEASUREMENT .... ‘SUBSEQUENT MEASUREMENT. TRANSFERS ... 431 DERECOGNITION... 432 DISCLOSURE... 434 Summat PAS 41 AGRICULTURE.. BIOLOGICAL ASSET... AGRICULTURAL PRODUCE .. MEASUREMENT..... GOVERNMENT GRANTS Disctosure... ootxiii SUMMARY: .....ssseeees PFRS 1 FIRST-TIME ADOPTION OF PHILIPPINE FINANCIAL REPORTING STANDARDS .. First PRS FINANCIAL STATEMENTS ... RECOGNITION AND MEASUREMENT. RETROSPECTIVE APPUCATION... PRESENTATION AND DISCLOSURE . SUMMARY: PFRS 2 SHARE-BASED PAYMENT... RECOGNITION... EQUITY-SETTLED SHARE-BASED PAYMENT TRANSACTIONS. Employee share option plans ... CASH-SETTLED SHARE-BASED PAYMENT TRANSACTIONS .. Employee share appreciation rights (SARs). CHOICE BETWEEN EQUITY-SETTLED AND CASH-SETTLED. Counterparty has the right of choice. Entity has the right of choice SUMMARY: .. mee i PFRS 3 BUSINESS COMBINATIONS.. BUSINESS COMBINATION ... ACCOUNTING FOR BUSINESS COMBINATION Recognizing and measuring goodwil SUMMARY: . PFRS 5 NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS.. CLASSIFICATION AS HELD FOR SALE MEASUREMENT... CHANGES TO A PLAN OF SALE DISCONTINUED OPERATION: PRESENTATION OF DISCONTINUED OPERATIONS. PRESENTATION IN THE STATEMENT OF FINANCIAL POSITION... ‘SUMMARY PFRS 6 EXPLORATION FOR AND EVALUATION OF MINERAL RESOURCES... wave 515xiv EXEMPTION FROM HIERARCHY OF REPORTING STANDARDS UNDER PAS 8, INITIAL MEASUREMENT ......- ‘SUBSEQUENT MEASUREMENT... 51g PFRS 7 FINANCIAL INSTRUMENTS: DISCLOSURES. SIGNIFICANCE OF FINANCIAL INSTRUMENTS .... crete NATURE AND EXTENT OF RISKS ARISING FROM FINANCIAL INSTRUMENTS... 525 PFRS 8 OPERATING SEGMENTS... CORE PRINCIPLE... OPERATING SEGMENTS. REPORTABLE SEGMENTS... MANaGeMment appRoact AGGREGATION CRITERIA... QUANTITATIVE THRESHOLDS SUMMARY: PFRS 9 FINANCIAL INSTRUMENTS... INITIAL RECOGNITION... CLASSIFICATION OF FINANCIAL ASSETS Business model ... Contractual cash flow characteristic MEASUREMENT OF FINANCIAL ASSETS.. RECLASSIFICATION IMPAIRMENT DERECOGNITION CLASSIFICATION OF FINANCIAL LIABILITIES MEASUREMENT OF FINANCIAL LIABILITIES, SUMMARY: PFRS 10 CONSOLIDATED FINANCIAL STATEMENTS... SAG Exposure or rights to variable returns Ability to use power to affect investor's returns ACCOUNTING REQUIREMENTS «sss. NON-CONTROLLING INTERESTS (NCI PREPARING THE CONSOLIDATED FINANCIAL STATEMENTS Summary:PFRS 16 LEASES xv PFRS 11 JOINT ARRANGEMENTS... JOINT ARRANGEMENT ... ‘TYPES OF JOINT ARRANGEMENT JOINT OPERATIONS JOINT VENTURES .. PRESENTATION IN STATEMENT OF FINANCIAL POSITIO| PARTICIPANT TO A JOINT ARRANGEMENT WITH NO JOINT CONTROL. SUMMARY: .... PFRS 12 DISCLOSURE OF INTERESTS IN OTHER ENTITIES ... SUMMARY OF MINIMUM DISCLOSURES UNDER PFRS 12... PFRS 13 FAIR VALUE MEASUREMENT... FAIR VALUE... REQUIREMENTS ON FAIR VALUE MEASUREMENT... VALUATION TECHNIQUES ....-sossse FAIR VALUE HIERARCHY...... FAIR VALUE MEASUREMENT OF NON-FINANCIAL ASSET: SuMMaRY: PFRS 14 REGULATORY DEFERRAL ACCOUNTS SCOPE... SUMMARY OF PRINCIPLES UNDER PFRS 14 ........ PFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS .. REVENUE RECOGNITION .. Step 1: Identify the contract with the customer..... Step 2: Identify the performance obligations in the contract .622 Step 3: Determine the transaction price .. S Step 4; Allocate the transaction price to the performance obligations ... Step 5: Recognize revenue when (or as) the entity satisfles 3 a performance obligation CONTRACT COSTS... PRESENTATION .. DisctosurE Summary: sssesereensees 646)xvi Lease IDENTIFYING A LEASE LEASE TERM . ACCOUNTING FOR LEASES BY LESSEE Recognition exemptions Separating the components of a contract Presentation.. Disclosure. ACCOUNTING FOR LEASES BY LESSO! Indicators of a finance lease: Inception and Commencement of lease... Finance Lease.. Operating Lease.. 674 Lease of land and building 175 Subleases .. 76 Presentation. Disclosure. ‘SALE AND LEASEBACK TRANSACTIONS .. ‘SUMMARY:...... PERS 17 INSURANCE CONTRACTS......... INSURANCE CONTRACT RECOGNITION... INITIAL MEASUREMENT, Fulfillment cash flows Contractual service margin. ‘SUBSEQUENT MEASUREMENT 693 ONEROUS CONTRACTS ..... 94 PREMIUM ALLOCATION APPROACH 95 REINSURANCE CONTRACTS HELD. 696 INVESTMENT CONTRACTS WITH DISCRETIONARY PARTICIPATION FEATURES . 698 MODIFICATION OF AN INSURANCE CONTRACT 199 DERECOGNITION PRESENTATION SUMMARY: REFERENCE...Overview of Accounting 1 Overview of Accounting Learning Objectives 1. Define accounting and state its basic purpose. 2. Explain the basic concepts applied in accounting. 3. State the branches of accounting and the sectors in the practice of accountancy. 4. Explain the importance of a uniform set of financial reporting standards. Definition of Accounting Accounting is “ "= (American Association of Accountants) Three important activities included in the definition of | accounting | 1. Identifying 2. Measuring | 3. Communicating Identifying a Identifying is the process of analyzing events and transactions to determine whether or not they will be recognized. > Recognition refers to the process of including the effects of an accountable event in the statement of financial position or the statement of comprehensive income through a journal entry. Qnilynccountableneventswatemrecognized (i.¢., journalized). An accouniableevent is one that affects the assets, liabilities, equity, income or expenses of an entity. It is also known as economic activity, which is the subject matter of accounting. Only economicee activities are emphasized and recognized in accounting. Sociological and psychological matters are not recognized. Non-accountable events are ot recognized but discloseg only in the notes, if they have accounting relevance. Disclosure only in the notes is not an application of the recognition process, 4, non-accountable event that has an accounting relevance may be recorded through a enmormdunmentrys Types of events or transactions 1. (Gxtemmmbevents> are events that involve an entity and another external party. Types of External events i. Exchange (reciprocal transfer) - an event wherein there is a reciprocal givit of economic resources or discharging of economic obligations between an entity and an external party. Examples: sale, purchase, payment of liabilities, receipt of notes receivable in exchange for accounts receivable, and the like. ii, Non-reciprocal transfer — is a Conexwaydatransactiom in that the party giving something does not receive anything in return while the party receiving does not give anything in exchange. Examples: donations, gifts or charitable contributions, payment of taxes, imposition of fines, theft, provision of capital by owners *, distributions to owners ‘ and the like. 1 FASB Accounting Standards Codification (ASC) 845 iii. External event other than transfer — an event that involves changes in the economic resources or obligations of a" entity caused by an external party or external source but does not involve transfers of resources or obligations. ealExamples: changes in fair values and price levels, obsolescence, technological changes, vandalism, and the like. 2. Internal events — are events that dGtiaminvolveransexternal party Types of Internal events i, Production - the qprogess by which resources are transformed intomfinishedegeods. Examples: conversion of raw materials into finished products, production of farm products, and the like. ii. Casualty — an unanticipated 188 from disasters or other similar events. Examples: loss from fire, flood, and other catastrophes Measuring Measuring involves assigning numbers, normally in monetary terms, to the economic transactions and events. Several measurement bases are’ used in accounting which include, but not limited to, historical cost, fair value, present value, realizable value, current cost, and sometimes inflation- adjusted costs. The most commonly used is historical cost. This is usually combined with the other measurement bases. Accordingly, financial statements are said to be prepared using a mixture of costs and nalues. istoric and current 6st whil Valuation by fact or opinion The use of estimates is essential in providing relevant information. id to be a mixture of fact and Thus, financial statements are sai opinion. When measurement is atfectedmbymestimatesp the items measured ’are said to be valued by opinion. Examples: a. Estimates of uncollectible amounts of receivables.Se Be b. Depreciation and amortization expenses, which are affectey | by estimates of useful life and residual value. 4 : Estimated liabilities, such as provisions. | Retained earnings, which is affected by various estimates of Income and expenses When measurement is «anmaficc@aOPCSHinate’, the items measured are said to be valued bygaet. Examples: a. Ordinary share capital valued at par value b. Land stated at acquisition cost © Cash measured at face amount Communicating Communicating is the process of transforming economic data into useful accounting information, such as financial statements and other accounting reports, for dissemination to users. It also involves interpreting the significance of the _ processed information. The communicating process of accounting involves three aspects: 1. Recording ~ refers to the process of systematically committing into writing the identified and measured accountable events in the journal through journal entries. 2. Classifying — involves the grouping of similar and interrelated items into their respective classes through postings in the ledger. 3. Summarizing — putting together or expressing in condensed form the recorded and classified transactions and events. This includes the preparation of financial statements and other accounting reports. Interpreting the processed information involves thé computation of financial statement ratios. Some regulatory bodies such as the Bangko Sentral ng Pilipinas (BSP), require certain financial ratios to be disclosed in the notes to financial statements. a_Overview of Accounting 5 Basic purpose of accounting The basic purpose of accounting is to provide information that is useful in making economic decisions. Various sources of information are used when making, economic decisions and the financial statements are only one of those sources, Other sources may include current events, industry publications, internet resources, professional advices, expert systems, etc. Economic entities use accounting to record economic activities, process data, and disseminate information intended to be useful in making economic decisions. An economic entity is a separately identifiable combination of persons and property that uses or controls economic resources to achieve certain goals or objectives. An economic entity may either be a: a. Not-for-profit entity - one that carries out some socially desirable needs of the community or its members and whose activities are not directed towards making profit; or b. Business entity ~ one that operates primarily for profit. Economic activities are activities that affect the economic resources (assets) and obligations (liabilities), and consequently, the equity of an economic entity. Economic activities include: 1. Production - the process of converting economic resources into outputs of goods and services that are intended to have greater utility than the required inputs. 2. Exchange - the process of trading resources or obligations for other resources or obligations. 3. Consumption - the process of using the final output of the production process. 4. Income distribution - the process of allocating rights to the use of output among individuals and groups in society. 5. Savings - the process of setting aside rights to present consumption in exchange for rights to future consumption. 6. Investment - the process of using current inputs to increase the stock of resources available for output as opposed to immediately consumable output.a | Types of information provided by accounting | 1. Quantitative information - information expressed in number, quantities, or units. : 2. Qualitative information — information expressed in words oy descriptive form. Qualitative information is found in the Notes, to financial statements as well as on the face of the othe, | financial statements. 3. Financial information - information expressed in money, Financial information is also quantitative information because monetary amounts are normally expressed in numbers. Types of accounting information classified as to users’ needs 1. General purpose accounting information - designed to meet the common needs of most statement users. This information is provided under financial accounting. General purpose information is governed by generally accepted accounting principles (GAAP) represented by the Philippine Financial Reporting Standards (PFRSs). 2. Special purpose accounting information - designed to meet the specific needs of particular statement users. This information is provided by other types of accounting other than financial accounting, e.g., managerial accounting, tax basis accounting. Sources of information in financial statements Information in the financial statements is not obtained exclusively from the entity’s accounting records. Some are obtained from external sources. For example, fair value measurements, resolutions of uncertainties, future lease payments, and contractual commitments are only a few of the information presented in the financial statements that are derived from external sources. Accounting as science and art 1. Asa social science, accounting is a body of knowledge which has been systematically gathered, classified and organized. PleaOverview of Accounting Z 2. Asa practical art, accounting, requires the use of creative skills and judgment Accounting as an information system Accounting identifies and measures economic activities, processes information into financial reports, and communicates these reports to decision makers, Accounting as a language of business Accounting is often referred to as a “language of. business” because it is fundamental to the communication of financial information. Creative and Critical thinking in accounting The practice of accountancy requires the exercise of creative and critical thinking. a. Creative thinking involves the use of imagination and insight to solve problems by finding new relationships (ideas) among items of information. (itislimosttimportanteineidentifying alternative solutions. b. Critical thinking involves the logical analysis of issues, using inductive or deductive reasoning to test new relationships to determine their effectiveness. Itismmostimportantinevaluating Creative skills and judgment are exercised in problem solving. The following are the steps in problem solving: 1. Recognizing a problem 2. Identifying alternative solutions 3. Evaluating the alternatives 4, Selecting a solution from among the alternatives 5. Implementing the solution Accounting Concepts Accounting concepts refer to the principles upon which the process of accounting is based. The term “accounting concepts” is used interchangeably with the following terms:. (Accounting postulates) — are the i assumptions * 4 Accounting assumpi asic Notions that fundamental concepts or principles : and b. provide the foundation of the accounting process. is logical reasoning in the form of a set of Accounting theory — 4 provide a general frame of reference broad principles that (i) eferen by which accounting practice can be evaluated and (ii) guide the development of new practices and procedures. It is the organized set of concepts and related principles that explain and guide the accountant’s action in identifying, measuring, communicating accounting information. Accounting theory comprises the Conceptual Framework and the Philippine Financial Reporting Standards (PFRSs). Most accounting concepts are derived from the Conceptual Framework and the Philippine Financial Reporting Standards (PFRSs), However, some accounting concepts are implicit, meaning they are not expressly stated in the Framework or PFRSs but are generally accepted because of their long-time use in the profession. Examples of accounting concepts: A, Double-entry system — each accountable event is recorded in two parts — debit and credit. Going concern assumption — the entity is assumed to carry on its operations for an indefinite period of time. Meaning, the entity does not expect to end its operations in the foreseeable future. The measurement basis involving mixture of costs and values is appropriate only when the entity is a going concern. If the entity is a liquidating concern, the appropriate measurement basis is realizable value, ie., estimated selling3, view of Accounti Separate entity (Accounting entity / Business entity concept! Entity concept) ~ the entity is viewed separately from its owners. Accordingly, the personal transactions of the owners among themselves or with other entities are not recorded in the entity’s accounting records. This concept defines the area of interest of the accountant, Stable monetary unit (Monetary unit assumption) a. Assets, liabilities, equity, income and expenses are stated in terms of a common unit* of measure, which is the peso in the Philippines; and b. The purchasing power of the peso is regarded as stable or constant and that its instability is insignificant and therefore ignored. *To be useful, accounting information should be stated in a common denominator. For example, amounts in foreign currencies should be translated into pesos. Time Period (Periodicity! Accounting period) ~ the life of the entity is divided into series of reporting periods. An accounting period is usually 12 months and may either be a calendar year or a fiscal year period. A calendar year period starts on January 1 and ends on December 31 of that same year. A fiscal year period also covers 12 months but starts on a date other than January 1. Materiality concept — information is material if its omission or misstatement could influence economic decisions. Materiality is a matter of professional judgment and is based on the size and nature of the item being judged. Cost-benefit (Cost constraint/ Reasonable assurance) - the cost of processing and communicating information should not exceed the benefits to be derived from it.wo a, 10. _ the effects of transactions and other events are recognized when they occur (and not as cag} is received or paid) and they are recorded in the accountin, records and reported in the financial statements of the periods to which they relate. Under accrual basis, rather than when cash recognized when incurred rath ‘Accrual Basis of accounting income is recognized when eared is collected and expenses are er than when cash is paid. Historical cost concept (Cost principle) ~ the value of an asset is determined on the basis of acquisition cost. This concept is not always maintained. Some PFRSs require the departure from this concept, such as when inventories are measured at net realizable value (NRV) rather than at cost when applying the “lower of cost and NRV" measurement. Concept of Articulation ~ all of the components of a complete set of financial statements are in.errelated. The preparation of a worksheet (and the eventual completion of the financial statements) recognizes that the financial statements are fundamentally interrelated and interact with each other. Accordingly, when users use the financial statements in making decisions, they need to use each financial statement in conjunction with the other financial statements. For example, when evaluating an entity’s ability to generate future cash flows, all the financial statements should be used and not only the statement of cash flows. Receivables and payables in the statement of financial position provide information on expected cash receipts a cash disbursements in future periods. _ Income and expenses in the statement of profit or loss amt other comprehensive income provide information 0% entity's ability to generate cash flows from its operations. aeOverview of Accounting i Al. 2, 13. 14, ~ Information on issued and unissued shares in the statement of changes in equity provides information on the availability of equity financing. - Information on historical changes in cash and cash equivalents in the siatement of cash flows helps users assess future sources and uses of funds. - The notes to financial statements provides information on the quality of earnings, e.g., whether income or expenses are realized or unrealized or whether they are recurring or non-recurring. Full disclosure principle — this principle recognizes that the nature and amount of information included in the financial statements reflect a series of judgmental trade-offs. The trade- offs strive for: a. sufficient detail to disclose matters that make a difference to users, yet b. sufficient condensation to make the information understandable, keeping in mind the costs of preparing and using it Consistency concept — the financial statements are prepared on the basis of accounting principles that are applied consistently from one period to the next. Changes in accounting policies are made only when required or permitted by the PFRSs or when the change results to more relevant and reliable information. Changes in accounting policies are disclosed in the notes. Matching (Association of cause and effect) - costs are recognized as expenses when the related revenue is recognized. Entity theory ~ the accounting objective is geared towards proper income determination. Proper matching of costs against revenues is the ultimate end. This theory emphasizes the12 Ss income statement and is exemplified by the equation “Assets Liabilities + Capital.” 15. Proprietary theory — the accounting objective is geareq towards the proper valuation of assets. This theory emphasize, the importance of the balance sheet and is exemplified by the equation “Assets — Liabilities = Capital.” 16. Residual equity theory — this theory is applicable when there are two classes of shares issued, ie, ordinary and preferred, The equation is “Assets — Liabilities — Preferred Shareholders’ Equity = Ordinary Shareholders’ Equity.” This theory is applied in the computation of book value per share and return on equity. 17. Fund theory - the accounting objective is neither proper income determination nor proper valuation of assets but the custody and administration of funds. The objective is directed towards cash flows, exemplified by the formula “cash inflows minus cash outflows equals fund.” This concept is used in government accounting and fiduciary accounting. 18. Realization — the process of converting non-cash assets into cash or claims for cash. It is also the concept that deals with revenue recognition. For example, realization occurs when goods are sold for cash or in exchange for accounts receivable or notes receivable. The goods are non-cash assets and they are converted into cash or, in the case of the receivables, claims for cash. 19. Prudence (Conservatism) ~ is the use of caution when making estimates under conditions of uncertainty, such that assets oT income are not overstated and liabilities or expenses are not understated. In other words, when exercising prudence, the one which has the least effect on equity is chosen: ill.Overview of Accounting 13 os However, the exercise of prudence does not allow the | deliberate understatement of assets or overstatement of | liabilities in order to create hidden reserves because the | financial statements would not be faithfully represented. | An example of a hidden reserve is the “cookie jar | reserve.” It is a form of fraudulent reporting wherein during | periods of high Profits, liabilities are overstated through | excessive provisions of expenses or non-recognition of income. | In subsequent periods, when the entity's financial performance is poor, the “cookie jar reserve” is reversed to income in order to report high profits. Management engages in such fraud because of various reasons, which may include smoothing earnings in order to secure bonuses over time, defer profits to the periods when they are evaluated for | Promotion or for election as members of the board of | directors, or to show profits when other entities belonging to the same industry show declining financial performance. Expense recognition principles 20. Matching concept (Direct association of costs and revenues) - costs that are directly related to the earning of revenue are recognized as expenses in the same period the related revenue is recognized For example, the cost of inventory is_ initially recognized as asset and recognized as expense (i.e., cost of sales) when the inventory is sold. Other examples include freight-out and sales commissions; these are expensed in the period the related sales are recognized. 21. Systematic and rational allocation — costs that are not directly related to the earning of revenue are initially recognized as assets and recognized as expenses over the periods their economic benefits are consumed, using some method of allocation. For example, the cost of equipment is initially recognized as asset and subsequently recognized as22. Se depreciation expense over the periods the equipment is Used, Other examples include amortization, expensing, of prepayments and effective interest method of allocation. Immediate recognition — costs that do not meet the definition of an asset, or ceases to meet the definition of an asset, are expensed immediately. Examples include casualty losses ang impairment losses. Common branches of accounting 1. Financial accounting — is the branch of accounting that focuses on general purpose financial statements. > General purpose financial statements are those statements that cater to the common needs of external users, primarily the potential and existing investors, and lenders and other creditors. External users are those who are not involved in managing the entity. > Financial accounting is governed by the Philippine Financial Reporting Standards (PFRSs). Financial accounting vs. Financial reporting The term “financial accounting” is often used interchangeably with the term “financial reporting.” Although, both financial accounting and financial reporting focus on general purpose financial statements, the latter endeavors to promote principles that are also useful in “other financial reporting.” “Other financial reporting” comprises information provided outside the financial statements that assists in the interpretation of a complete set of financial statements of improves users’ ability to make efficient economic decisions. Financial statements vs. Financial report > Financial statements are the structured representation of an entity’s financial position and Tesults of its operations. They are the end product of the accounting process and the means by which information gathered and processed are periodically communicated to users.of Accounting 15 » A financial report includes the financial statements plus other information provided outside the financial statements that assists in the interpretation of a complete set of financial statements or improves users’ ability to make efficient economic decisions, Financial statements Financial report 1. Statement of financial 1. Statement of financial position position 2. Statement of profit or loss 2, Statement of profit or loss and other comprehensive and other comprehensive income income 3. Statement of changes in 3. Statement of changes in equity equity 4. Statement of cash flows 4. Statement of cash flows 5. Notes 5. Notes 6. Additional statement of 6. Additional statement of financial position financial position 2. Other information Financial reporting is the provision of financial information about an entity that is useful to external users, primarily the investors, lenders, and other creditors, in making investment and credit decisions. Primary objective of financial reporting To provide information about an entity's economic resources, claims to those resources, and changes in those resources. Secondary objective of financial reporting To provide information useful in assessing the entity’s management stewardship (ie., how efficiently and effectively the entity’s management has discharged its responsibilities to use the entity’s economic resources).a 2. Management accounting — refers to the accumulation ani communication of information for use by internal users Or management. An offshoot of management accounting ii management advisory services which includes services to clients on matters of accounting, finance, business Policies, organization procedures, product costs, distribution, ang many other phases of business conduct and operations. 3. Cost accounting — is the systematic recording and analysis of the costs of materials, labor, and overhead incident to production. 4. Auditing — is the process of evaluating the correspondence of certain assertions with established criteria and expressing an opinion thereon. 5. Tax accounting - the preparation of tax returns and rendering of tax advice, such as the determination of the tax consequences of certain proposed business endeavors. 6. Government accounting - refers to the accounting for the government and its instrumentalities, placing emphasis on the custody of public funds, the purposes for which those funds are committed, and the responsibility and accountability of the individuals entrusted with those funds. 7. Fiduciary accounting — refers to the handling of accounts managed by a person entrusted with the custody and management of property for the benefit of another. 8. Estate accounting - refers to the handling of accounts for fiduciaries who wind up the affairs of a deceased person. 9. Social accounting (social and environmental accounting or social responsibility reporting) - the Process of communicating the social and environmental effects of an entity's economic actions to the society, ler Atel A ealOverview of Accounting v7 10. Institutional accounting — the accounting, for non-profit entities other than the government. 11, Accounting systems ~ the installation of accounting procedures for the accumulation of financial data and designing of accounting forms to be used in data gathering. 12. Accounting research - pertains to the careful analysis of economic events and other variables to understand their impact on decisions. Accounting research includes a broad range of topics, which may be related to one or more of the other branches of accounting, the economy as a whole, or the market environment. Bookkeeping and Accounting Bookkeeping refers to the process of recording the accounts or transactions of an entity. Bookkeeping normally ends with the preparation of the trial balance. Unlike accounting, bookkeeping does not require the interpretation of the significance of the processed information. Accountancy Accountancy refers to the profession or practice of accounting. The practice of accounting can be broadly classified into two ~ (1) Public practice and (2) Private practice. Public practice does not involve an employer-employee relationship while private practice involves an employer-employee relationship, meaning the accountant is an employee. Four sectors in the practice of accountancy Under R.A. 9298 also known as the “Philippine Accountancy Act of 2004,” the practice of accounting is sub-classified into the following: : 1. Practice of Public Accountancy ~ involves the rendering of audit or accounting related services to more than one client on a fee basis.18 ee 2. Practice in Commerce and Industry - refers to employment in the private sector in a position which involves decision making requiring professional knowledge in the science of accounting and such position requires that the holder thereo¢ must be a certified public accountant. 3. Practice in Education/Academe - employment in an educational institution which involves teaching of accounting, auditing, management advisory services, finance, business law, taxation, and other technically related subjects. 4. Practice in the Government - employment or appointment to | a position in an accounting professional group in the government or in a government-owned and/or controlled corporation, including those performing proprietary functions, where decision making requires professional knowledge in the science of accounting, or where civil service eligibility as a certified public accountant is a prerequisite. Accountants practicing under numbers 2 to 4 above are considered in private practice. Accounting standards The Philippine Financial Reporting Standards (PFRSs) represent the generally accepted accounting principles (GAAP) in the Philippines. The PERSs are Standards and Interpretations adopted by the Financial Reporting Standards Council (FRSC). They comprise: a. Philippine Financial Reporting Standards (PFRSs); b. Philippine Accounting Standards (PASs); and c. Interpretations PFRSs are accompanied by guidance to assist entities in applying their requirements. A guidance states whether it is a" 2A of Accounting 19 integral part of the PERSs, A guidance that is an integral part of the PFRSs is mandatory. The need for reporting standards For financial statements to be useful, they should be prepared using reporting standards that are generally acceptable. Otherwise, each entity would have to develop its own standards. If that is the case, every entity may just present any asset or income it wants and omit any liability or expense it does not want. Financial statements would not be comparable, the risk of fraudulent reporting is heightened, and economic decisions based on these financial statements would be grossly incorrect. For this reason, entities should follow a uniform set of reporting standards when preparing and presenting financial statements. The term “generally acceptable” means that either: 1, the standard has been established by an authoritative accounting rule-making body, e.g., the PFRSs adopted by the FRSC; or 2. the principle has gained general acceptance due to practice over time and has been proven to be most useful, e.g,, double- entry recording and other implicit concepts. The process of establishing financial accounting standards is a democratic process in that a majority of practicing accountants must agree with a standard before it becomes implemented. Hierarchy of Reporting Standards When selecting its accounting policies, following in descending order: 1. Philippine Financial Reporting Standards (PFRSs) 2. In the absence of a PFRS that specifically applies to a transaction or event, managenient shall use its judgment in developing and applying an accounting policy that results in information that is relevant and reliable. an entity considers the In making the judgment,20 cn ces | 1, management shall refer to, and consider the applicability of, the following sources in descending onder: a, The requirements in PFRSs dealing with similar ang related issues; b. The Conceptual Framework. 2. management may also consider the following: a. Pronouncements of other standard-setting bodies b. Accounting literature and accepted industry practices (PAS 87-12) 2) The term “shall” as used in the PFRSs means ‘must’ or it is required, while the term “may” means it is optional or ‘may or may not’. Although the selection of appropriate accounting, policies is the responsibility of the entity's management, the proper application of accounting principles is most dependent upon the professional judgment of the accountant. Accounting standard setting bodies and other relevant organizations 1, Financial Reporting Standards Council (FRSC) - is the official accounting standard setting body in the Philippines created under the Philippine Accountancy Act of 2004 (R.A. No. 9298). The FRSC is composed of fifteen (15) individuals - a chairperson who had been or presently a senior accounting practitioner in any of the scope of accounting practice and fourteen (14) representative members: Chairperson 1 Fourteen representative members from: Board of Accountancy (BIR) Commission on Audit (COA) Securities and Exchange Commission (SEC) Bangko Sentral ng Pilipinas (BSP) Bureau of Internal Revenue (BIR) A major organization composed of Preparers and users of financial statements BPE eeeOverview of Accounting un Accredited National Professional Organization of CPAs (ie, PICPA): Public Practice 2 Commerce and Industry 2 Academe/Education 2 Government 2 B14 Total as (Rules and Regulations Implementing R.A. 9298, Sec. 9(A)) 2. Philippine Interpretations Committee (PIC) - is a committee formed by the Accounting Standards Council (ASC), the predecessor of FRSC, with the role of reviewing the interpretations of the International Financial Reporting Interpretations Committee (IFRIC) for approval and adoption by the FRSC. 3. Board of Accountancy (BOA) — is the professional regulatory board created under R.A. No. 9298 to supervise the registration, licensure and practice of accountancy in the Philippines. The BOA consists of a chairperson and six (6) members appointed by the President of the Philippines. The Board shall elect a vice-chairperson from among its members for a term of one (1) year. 4. Securities and Exchange Commission (SEC) - is the government agency tasked in regulating corporations and partnerships, capital and investment markets, and the investing public. Some SEC rulings affect the accounting requirements of entities and the adoption and application of accounting policies. of the National Internal Revenue Code. These provisions do s reflect the goals of financial reporting. However, | 5. Bureau of Internal Revenue (BIR) - administers the provisions t I | ce of accounting methods not alway: A they do at times influence the choi | and procedures.22 — 6. Bangko Sentral ng Pilipinas (BSP) - influences the selection and application of accounting policies by banks and other entities performing banking functions. 7. Cooperative Development Authority (CDA) ~ influences the selection and application of accounting policies by cooperatives. Accounting policies prescribed by a regulatory body (e.g, BSP, CDA) are sometimes referred to as regulatory accounting principles. International Accounting Standards The International Accounting Standards Board (IASB) is the standard-setting body of the IFRS Foundation with the main objectives of developing and promoting global accounting standards. The IASB was established in April 1, 2001 as part of the International Accounting Standards Committee (IASC) Foundation. The IASC Foundation is a non-profit organization based in Delaware, USA and is the parent of the LASB, which is based in London. On July 1, 2010, the IASC Foundation was renamed to International Financial Reporting Standards Foundation or IFRS Foundation. The standards issued by the IASB are the International Financial Reporting Standards (IFRSs), composed of the following: 1, International Financial Reporting Standards (IFRSs) 2. International Accounting Standards (IASs) 3. Interpretations The IFRSs are standards issued by the IASB after it replaced its predecessor, the International Accounting Standards Committee (IASC), in April 1, 2001. The IASs are standards issued by the IASC which were adopted by the IASB, The PFRSs and PASs are based on these standards. alllveiw of Accum 3 was established as ies in ten national 1 board, namely, The IASC was founded in June 1973. It agreement by accountancy bod' a result of an hich constituted the original jurisdictions wi ‘Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the UK, Ireland and the US. Due process The IFRSs are that involves accountants and organizations from around the world. involves the following steps: 1, The staff identifies and reviews issues associated with a topic and considers the application of the Conceptual Framework to the issues; 2. Study of national acc including consultation wi 3, Consulting the Trustees an advisability of adding the topic to 4, Formation of an advisory group to developed through an international due process and other various interested individuals Due process normally counting requirements and practice, ith national standard-setters; d the Advisory Council about the the IASB’s agenda; give advice to the [ASB on the project; 5, Publishing a discussion document for public comment; 6. Publishing an exposure draft for public comment; 7, Publishing with an exposure draft a basis for conclusions and the alternative views of any IASB member who opposes publication; 8. Consideration o 9, Holding a public necessary; and 10. Publishing a standa’ explaining, among process and how the exposure draft, and (ii) the disse member. (Preface to TFRS.17) f all comments received; hearing and conducting field tests, if rd “, including (i) a basis for conclusions, other things, the steps in the IASB’s due IASB dealt with public comments on the nting opinion of any TASB © Approved by at least 8 votes of the TASB if there are fewer than 14 members, or by 9 ifthere are 14 members.mo Other relevant international organizations ; 1. International Financial Reporting Interpretations Committe, (IFRIC) - is a committee that prepares interpretations of how specific issues should be accounted for under the application of IFRS where: - a. The standards do not include specific authoritative guidance; and b. There is a risk of divergent and unacceptable accounting practices. The IFRIC is composed mostly of technical partners in audit firms but also includes preparers and users. In 2002, IFRIC replaced the former Standing Interpretations Committee (SIC) which had been created by the IASC. All of the SIC Interpretations have been adopted by the TASB. 2. IFRS Advisory Council (previously known as the Standards Advisory Council ‘SAC’) - is a group of organizations and individuals with an interest in international financial reporting. The Advisory Council's role includes advising on priorities within the IASB’s work program. The IASB is required to consult with the Advisory Council in advance of any board decisions on major projects that it wishes to add to its agenda. Members of the Advisory Council are appointed by the IFRS Foundation which also appoints members to the IASB. These members are drawn from different geographic locations and have a wide variety of backgrounds, including users, preparers, academics, auditors, analysts, regulators and professional accounting bodies. 3. International Federation of Accountants (IFAC) - is a non- profit, non-governmental, non-political organization of accountancy bodies that represents the worldwide accountancy profession. Its mission is to develop and enhance cellOverview of Accounting the profession to provide services of consistently high quality in the public interest. Membership to the IFAC is open to all accountancy bodies recognized by law or consensus within their countries. 4. International Organization of Securities Commissions (IOSCO) — is an international body of security commissions. The Philippine SEC is a member of IOSCO. Move to IFRSs Prior to the full adoption of the IFRSs in 2005, the accounting standards used in the Philippines were previously based on US GAAP, ie., the Statements of Financial Accounting Standards issued by the Federal Accounting Standards Board (FASB), the US. national standard setting body. The move to IFRSs was primarily brought about by the increasing acceptance of IFRSs world-wide and increasing internationalization of businesses thereby increasing the need for a common financial reporting standards that minimize, if not eliminate, inconsistencies of financial reporting among nations. “A good example of inconsistent national financial reporting is that of German car manufacturer Daimler-Benz AG (prior to its merger with Chrysler). Daimler-Benz obtained a listing of its shares in the US in 1993, and in so doing needed to report under both U.S. GAAP and German GAAP. While one might expect that the profit reported would be similar (as it was exactly the same set of economic transactions being presented), this was not the case. The company reported a huge loss of $1 billion under US GAAP, while at the same time reporting a profit of $370 million under its own domestic German GAAP. This difference was simply the result of different accounting practices being used by different countries. Such significant differences sefulness of financial statements.” (source: The institute of undermine the u: ‘and Wiles, “International Financial Reporting Standards - Cerlificate Chartered Accountants in England Learning muterils’)26 mo The future of IFRSs A significant milestone towards achieving the goal of havin, set of global standards was reached in October 2002 when FASB and the IASB entered into a memorandum of unders| called the “Norwalk Agreement.” : In this Agreement, the FASB and the [ASB formalizey their commitment to the convergence of U.S. GAAP and TERSs by agreeing to use their best efforts to: a. make their existing financial reporting standards fully compatible as soon as practicable, i.e, minimize differences and ' b. coordinate their future work programs to ensure that once achieved, compatibility is maintained. landing Since the publication of the Norwalk Agreement, the LASp and FASB have been working together with the common goal of producing a single set of global accounting standards. “In a public statement issued in January 2017, the outgoing (US) SEC Chair expressed support for the development of high-quality, globally accepted accounting standards, and suggested that the (US) SEC support further efforts by the FASB and IASB to converge their accounting standards to enhance the quality and comparability of financial reporting.” (gource: http://www. pwe.com/us/en/ctodirect/issues/ifrs-adoption-convergence.html) Changes in reporting standards Once established, financial reporting standards are continually reviewed, revised or superseded. Changes to reporting standards are primarily made in response to users’ needs, Users’ needs for financial information change, and so must financial reporting standards in order to continually provide useful information. Legal, political, business and social environments also influence changes in reporting standards, Regulatory bodies, lobbyists, laws and regulations, and changes in economic environments affect the choice of accounting treatment provided under the reporting standards. ilealwv of Accounting 7 Summary: Accounting involves the activities of identifying, measuring, and communicating information that is useful in making economic decisions, Recognition refers to the process of incorporating the effects of an accountable event in the financial statements through a journal entry. External events are events which involve an entity and another external party. It includes (a) exchanges, (b) non-reciprocal transfers, and (c) external events other than transfers. Internal events are events which do not involve an external party. It includes (a) production and (b) casualties. Measuring is the accounting process of assigning numbers, commonly in monetary terms, to the economic transactions and events. Several measurement bases are used in preparing financial statements. Financial accounting is the branch of accounting that focuses on the general purpose financial statements. General purpose financial statements are those that cater to the common needs of a wide range of external users. External users are those who do not have the authority to demand financial reports tailored to their specific needs. The four sectors in the practice of accountancy are: (a) public practice, (b) commerce and industry, (c) academe, and (d) government. The accounting standards used in the Philippines are the PERSs, which are based on the IFRSs. The PFRSs comprise the following: (1) PERSs, (2) PASs, and (3) Interpretations. The Financial Reporting Standards Council (FRSC) is the official accounting standard setting body in the Philippines. Financial reporting standards continuously change primarily in response to users’ needs.wo PROBLEMS PROBLEM 1: TRUE OR FALSE 1, 10. All events and transactions of an entity are recognized the books of accounts. The accounting process of assigning numbers, commonly in monetary terms, to the economic transactions and events is referred to as classifying. The basic purpose of accounting is to provide information about economic activities intended to be useful in making economic decisions. Financial accounting is the branch of accounting that focuses on general purpose reports of financial position and operating results known as the financial statements. General purpose financial statements are those statements that cater to the common and specific needs of a wide range of external users. The financial statements are the only source of information when making economic decisions. All information presented in the financial statements are sourced from the accounting records of the entity. Entity A’s accounting period starts on July 1 and ends on June 30 of the following year. Entity A uses a fiscal year period. Once promulgated, accounting standards are never changed. The entity's management is responsible for the selection of appropriate accounting policies, not the accountant. PROBLEM 2: MULTIPLE CHOICE 1. The concept of recognition is applied in which of the following instances? a. An entity includes the effects of an event in the financial statements through a journal entry. b. An entity Temoves the effects of an event from the financial statements through a journal entry.w of Accounting 2 c. Anentity discloses only an event in the notes, rather than including the effects of the event in the monetary totals in the financial statements. d, Anentity records an event through a memorandum entry. Which of the following events is not considered an exchange or reciprocal transfer? a. purchase of inventory on account b. lending money to another entity c. payment of a loan payable d. payment of taxes Which of the following events is considered a nonreciprocal transfer? a. sale of anasset c. loss from a calamity b. donation d. production of finished goods To be useful, accounting information should be presented using a. monetary amounts. c. historical costs. b. acommon denominator. d. fair values. Which of the following violates the historical cost concept? Recording purchases of merchandise inventory at the purchase price. b. Recording a building at the total construction costs. Measuring inventories at net realizable value. equipment acquired in an installment a. c d. Recording an purchase at the cash price equivalent. Entity A values its fixed assets at their historical costs and does not restate them for changes in the purchasing power of the Philippine pesos due to inflation. Entity A is applying which of the following accounting concepts? cc. stable monetary unit a. prudence d..time period b. accrual basisBO A 10. Entity A engages in importing and exporting seu At the end of the period, Entity A has assets an liabiliteg denominated in foreign currencies. When preparing its financial statements, Entity A translates these assets ang liabilities to pesos. Entity A is most likely to be applying which of the following accounting concepts? a, double entry c. stable monetary unit b. accrual basis d. time period Preparing financial statements at least annually is an application of which of the following accounting concepts? a. historical cost c. stable monetary unit b. accrual basis d. time period Entity A acquires merchandise inventory. Entity A initially records the acquisition cost of the inventory as asset rather than an outright expense. When the inventory is subsequently sold, Entity A recognizes the cost of the inventory sold as expense, in the same period the sale revenue is recognized. This is an application of which of the following accounting concepts? a. stable monetary unit c. matching b. materiality d. proprietary On Day 1, a customer buys goods from Entity A and promises to pay the sale price on Day 30. Entity A recognizes sales ° revenue on Day 1 rather than on Day 30. This is an application of which of the following accounting concepts? a. prudence ¢. consistency b. accrual basis d, materiality31 of Accounting pROBLEM 3: MULTIPLE CHOICE 1 All of the following are considered internal events, except a. transfer of goods from work-in-process to finished goods inventory b. losses from flood, earthquake, fire and other calamities transformation of biological assets from immature to mature d, vandalism committed by the entity's employees Which of the following is considered an internal user of Entity A's financial reports? a. Entity B, a bank, requires Entity A to submit audited financial statements in conjunction to a loan being applied for by Entity A. b. Mr. Lis deciding whether to invest in Entity A. Mr. I uses Entity A’s financial statements in making its investment decision. Ms. §, a shareholder of Entity A, is deciding whether to hold or sell her shareholdings in Entity A. Ms. S uses Entity A’s financial statements in making its “hold or sell” decision. d. Mr. X, a member of Entity A’s board of directors, uses financial reports to make decisions regarding the financial and operational affairs of Entity A. When resolving accounting problems not specifically addressed by current standards, an entity shall be guided by the hierarchy of financial reporting standards. The ‘correct sequence of the hierarchy of financial reporting standards in the Philippines is PASs, PFRSs and Interpretations Conceptual Framework. Judgment Pronouncement of other standard-setting bodies a. 1, I, Hf and [V c. LIV, Mand OLFs b. LIL Wand Ill d.I, If, land Iv j 4. The proper application of accounting principles is Most dependent upon the c. auditor. a. management. ] b. accountant. d. chief executive officer. j 5. Which of the following statements is correct? a. Accounting provides quantitative information only, b. Accounting is considered an art because it requires the use of creative skills and judgment. c. The only acceptable measurement basis in accounting jg historical cost. d. Qualitative information can be found only in the notes to the financial statements. 6. Which of the following statements is correct? a, All quantitative information are also financial in nature. b. The accounting process of assigning peso amounts to economic transactions and events is measuring. c. The economic activity that involves using current inputs to imerease the stock of resources available for output is called savings. d. The economic activity of using the final output of the production process is called income distribytion. 7. Which of the following statements is incorrect regarding accounting concepts? a. Under the Accrual Basis of accounting, revenues ale recognized when earned and expenses are recognized when incurred, not when cash is received and disbursed. b. Under the Going concern concept, the business entity is assumed to carry on its operations for an indefinite period of time. ae |Overview of Accounting 33 10. c. Under the Business entity/ Separate entity/ Entity/ Accounting entity Concept, the business is treated separately from its owners, d. Under the Time Period/ Periodicity/ Accounting Period concept, the life of the business is divided into series of reporting periods. e. Under the Cost-benefit concept, the cost of processing and communicating information should exceed the benefits derived from it. Which of the following statements is incorrect? a. Financial reporting standards may at times be influenced by legal, political, business and social environments. b. General-purpose financial statements must be prepared by a Certified Public Accountant. c. General purpose financial statements are prepared primarily for the use of external users. d. The PFRSs ‘are issued by the Financial Reporting Standards Council. Mr. John Doe, CPA, is a professor in a’university where he teaches mainly home economics, music and physical education. Those subjects require that the teacher must be awesome. Mr. Doe is also frequently invited as a judge in beauty pageants and singing contests and as a referee in mixed martial arts competitions. Mr. Doe is considered to be practicing accountancy in which of the following sectors? c. Commerce and industry a, Academe d. None of these b. Public accounting Changes to reporting standards are primarily made in response to a. government regulations. b, users’ needs. c. global modernization. d. all of theseer PROBLEM 4: FOR CLASSROOM DISCUSSION Events 1, Entity A buys bananas and The conversion of bananas 1n| a. non-accountable event . b. external event. converts them into banana chips to banana chips is a (an) c. non-reciprocal transfer, | d. internal event. j | Valuation by fact or opinion | 2. Which of the following is considered valued by fact rather | than by opinion? a. Depreciation b. Cost of goods sold cc. Discount on share capital d. Retained earnings Measurement Bases 3. Which of the following is not one of the several measurement bases used in accounting? a. historical cost b. fair value c. present value d. all of these are used Accounting Concepts 4. Entity Ais owned by Mr. X and Ms. Y. Which of the following transactions does not violate the separate entity concept and therefore is appropriately recorded in the accounting records of Entity A? a. Mr. X purchases groceries for his home consumption. b. Mr. X gives Ms. Y chocolate and flowers on Valentine's Day. c. Ms. ¥ provides capital to Entity A. d. Ms. Y provides capital to Entity B, another business entity. 5. Mr. A is assessing the ability of Entity A to generate future cash and cash equivalents. In making the assessment, Mr. A uses not only the statement of cash flows but also the other components of a complete set of financial statements. This is because of which of the following concepts? fTateleeOverview of Accounting - Se a. Going concern c. Intercalation b. Time period d. Articulation 6. Entity A acquires a stapler. Instead of recognizing the cost of the stapler as an asset to be subsequently depreciated, Entity A immediately charges it as expense. This is an application of which of the following concepts? a. Prudence c. Cost-benefit b. Materiality d.bandc Common branches of accounting 7. What type of users’ needs is catered by general purpose financial statements? a. common needs c.aandb b. specific needs, d. neither a nor b Four sectors in the practice of accountancy 8. Which of the following is not among the Four Sectors in the practice of accountancy as enumerated in R.A. 9298 also known as the “Philippine Accountancy Act of 2004”? a. Practice in Commerce and Industry b. Practice in the Government ¢. Practice in Education/Academe d. Practice of Private Accountancy Accounting standards 9. The Philippine Financial Reporting Standards (PERSs) comprise: I. __ Philippine Financial Reporting Standards Il. Philippine Accounting Standards Tl. Interpretations IV. Accounting Practice Statements and Implementation Guidance a. 1, Hand Ml b. LIL Uland IV c. Land IE di land OF36 ae 10. Which of the following statements is incorrect Tegarding the PERSs? a. The PFRSs are based on the IFRSs , b. The financial reporting standards used in the Philippine, are the same as those used globally. c. The PFRSs have higher authority than the PASs an, 4 Interpretations. d. The PFRSs are accompanied by guidance. The use of such guidance is sometimes mandatory and sometimes optional.[ Learning Objectives Framework 37 Conceptual Framework for Financial Reporting eee State the purpose, Status, and scope of the Conceptual Framework. State the objective of financial reporting. Identify the primary users of financial statements. Explain briefly the qualitative characteristics of useful information and how they are applied in financial reporting. Define the elements of financial statements and state their recognition criteria and their derecognition. State the measurement bases used in financial reporting. Purpose of the Conceptual Framework The Conceptual Framework prescribes the concepts for general purpose financial reporting. Its purpose is to: a. b. assist the International Accounting Standards Board (IASB) in developing Standards* that are based on consistent concepts; assist preparers in developing consistent accounting policies when no Standard applies to a particular transaction or when a Standard allows a choice of accounting policy; and assist all parties in understanding and interpreting the Standards. * In our succeeding discussions, we will use the term Standard(s) to refer to both the International Financial Reporting Standards (IFRS) and the Philippine Financia? Reporting Standards (PFRS). The Conceptual Framework provides the foundation for the development of Standards that: a b. promote transparency by enhancing the international comparability and quality of financial information. ; strengthen accountability by reducing the information gap between providers of capital and the entity's management, | | | |38 Se © contribute to economic efficiency by helping investors 4, identify opportunities and risks around the world, thy, improving capital allocation. The use of a single, trusted accounting language lowers the cost of capital and reduces international reporting costs. (Conceptual Framework SP15) Status of the Conceptual Framework The Conceptual Framework is not a Standard. If there is a conflict between a Standard and the Conceptual Framework, the requirement of the Standard will prevail. The authoritative status of the Conceptual Framework is depicted in the hierarchy of guidance shown below: 4 Hierarchy of reporting standards 1. PERSs i 2. Judgment When making the judgment: > Management shail consider the following: a. Requirements in other PFRSs dealing with similar transactions b. Conceptual Framework | >» Management may consider the following: | a. Pronouncements issued by other standard-setting bodies b. Other accounting literature and industry practices The hierarchy guidance above means that in the absence of a PERS that specifically applies to a transaction, management shall consider the applicability of the Conceptual Framework in developing and applying an accounting policy that results in useful information. To meet the objectives of general purpose financial reporting, a Standard sometimes contains requirements that depatt from the Conceptual Framework. In such cases, the departure is explained in the ‘Basis for Conclusions’ on that Standard. The Conceptual Framework may be revised from time '© time based on the IASB's experience of working with it. However revisions do not automatically result to changes in the Standards - estan3 ptual Framework not until after the [ASB goes through its due process of amending a Siandard. Scope of the Conceptual Framework The Conceptual Framework is concerned with general purpose financial reporting. General purpose financial reporting involves the preparation of general purpose financial statements. The Conceptual Framework provides the concepts that underlie general purpose financial reporting with regard to the following: 1. The objective of financial reporting Qualitative characteristics of useful financial information Financial statements and the reporting entity The elements of financial statements Recognition and derecognition Measurement Presentation and disclosure Concepts of capital and capital maintenance SI eoRen The Objective of Financial Reporting “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 about providing resources to the entity.” (Conceptual Framework.1.2) This objective is the foundation of the Conceptual Framework. All the other aspects of the Conceptual Framework revolve around this objective. Primary users The objective of financial rep called the primary users: 1. Existing and potential investors; 2. Lenders and other creditors orting refers to the following, so and e users cannot demand information directly from ties and must rely on general purpose financial much of _ their financial information needs. Thes reporting enti reports for40 ae Ee Accordingly, they are the primary users to whom general purpo, financial Teports are directed to. s Lenders refer to those who extend loans (e.g,, banks while other creditors refer to those who extend other forms of credit (e.g, supplier). The Conceptual Framework is concerne Purpose financial reporting. General (or simply ‘financial Teporting’) that caters to the common need: od with genera | purpose financial Teportin, deals with providing information Is of the primary users, Therefore, general purpose financial reports do not and cannot provide al] the information needs of primary users. These users will need tg consider other sources for their other information needs (for example, general economic conditions and expectations, Political events and political climate, and industry and company outlooks), The information needs of individual primary users may differ and possibly conflict. Accordingly, financial reporting aims to provide information that meets the needs of the maximum number of primary users. Focusing on common needs, however, does not prohibit the Provision of additional information that is most useful to a particular subset of primary users. Other users, such as the entity's management, regulators, and the public, may find general purpose financial reports useful. However, such reports are not primarily directed to these users. General purpose financial reports do not directly show the value of a reporting entity. However, they provide information that helps users in estimating the value of an entity. Providing useful information requires making estimates and judgments. The Conceptual Framework establishes the concepts that underlie those estimates and judgments, Decisions about providing resources to the entity The primary users’ decisions about providing resources to the entity involve decisions on: a, buying, selling or holding investments; b. providing or settling loans and other forms of credit; or aie41 c. exercising voting or similar tights that could influence management's actions relating to the use of the entity’s economic resources. These decisions depend on the investoi/lender/other creditor's expected returns (e.g., investment income or repayment of loan) ‘pectations about returns, in turn, depend on assessments of the entity’s (i) prospects ‘for future net cash inflows and (ii) management stewardship. To make these assessments, investors, lenders and other creditors need information on: a. the economic resources of the entity, claims against the entity and changes in those resources and daims; and b. how efficiently and effectively the entity's management has utilized the entity’s economic resources. Information on Economic resources, Claims, and Changes General purpose financial reports provide information on a reporting entity’s: a. Financial position — information on economic resources (assets) and claims against the reporting entity (liabilities and equity); and b. Changes in economic resources and claims - information on financial performance (income and expenses) and other transactions and events that lead to changes in financial position. Collectively, these are referred to under the Conceptual Framework as the economic phenomena. Economic resources and Claims : / Information about the nature and amounts of an entity’s economic resources (assets) and claims (liabilities and equity) can help users to identify the entity’s financial strengths and weaknesses, That information can help users in assessing the entity's: a. Liquidity and solvency; oh b. Needs for additional financing and how successful it is likely to be in obtaining that financing; andBn Management's stewardship on the use of economic TeSoUurces Liquidity refers to an entity's ability to pay short-term obligations, while solvency refers to an entity's ability to mee its long-term obligations. . All of these contribute to the assessment of th ability to generate future cash flows. For example: ~ _ Information on currently maturing receivables and obligations can help users assess the timing of future cash flows. Information about the nature of economic resources can heh users assess whether a resource can produce future cash flows independently or only in combination with other resources, Information on liquidity and solvency can help users assess the entity's ability to obtain additional financing Overleverage (use of too much debt) may cause difficulty in obtaining additional financing. - Information about priorities and payment requirements of claims can help users predict how future cash flows will likely to be distributed among the claims. e entity's Changes in economic resources and claims Changes in economic resources and claims result from: a. financial performance (income and expenses); and b. other events and transactions. Information on financial performance helps users assess the entity’s ability to produce return from its economic resources Return provides an indication on how well management has efficiently and effectively used the entity’s resources. | Information on the variability of the return helps users it assessing the uncertainty of future cash flows. For example, significant fluctuations in reported profits may indicate faanet instability and uncertainty on the entity's ability to generate © flows from its operations.43 Information based on accrual accounting provides a better basis for assessing an entity's financial performance than information based solely on cash receipts and payments during the period. Information on past cash flows helps users assess the entity's ability to generate future cash flows by providing users a basis in understanding the entity's operating, investing and financing activities, assessing its liquidity or solvency, and interpreting other information about its financial performance. Economic resources and claims may also change for reasons aside from financial performance, such as issuing debt or equity instruments. Information on these types of changes is necessary for a complete understanding of the entity's changes in economic resources and claims and the possible impact of those changes on the entity’s future financial performance. Information about use of the entity's economic resources Information on how efficiently and effectively the entity's management has discharged its responsibilities to use the entity's economic resources helps users assess the entity’s management's stewardship. This information also helps in predicting how efficiently and effectively the entity's resources will be used in future periods; thus, helping in the assessment of the entity’s prospects for future net cash inflows. Examples of management's responsibilities to use the entity’s economic resources include safeguarding those resources and ensuring the entity’s compliance with laws, regulations and contractual provisions. | Summary: | The decisions of primary users are based on assessments of an | | entity’s prospects for future net cash inflows and management stewardship. | To make these assessments, users need information on the entity’s | financial position, financial performance and other changes in | financial position, and utilization of economic resources. _OOOO Qualitative Characteristics ne ., The qualitative characteristics of useful financial informatio, identify the types of information that are likely to be most usefu) to the primary users in making decisions using an entity's financial report. Qualitative characteristics apply to information in the financial statements as well as to financial information provided in other ways. The Conceptual Framework classifies the qualitative characteristics into the following: 1. Fundamental qualitative characteristics — these are the characteristics that make information useful to users. They consist of the following: a. Relevance b. Faithful representation 2. Enhancing qualitative characteristics - these are the characteristics that enhance the usefulness of information. They consist of the following: a. Comparability b. Verifiability c. Timeliness d. Understandability Fundamental qualitative characteristics Relevance Information is relevant if it can make a difference in the decisions of users. Relevant information has the following: a. Predictive value — the information can help users in making predictions about future outcomes. b. Confirmatory value (feedback value) - the information can help users in confirming their Previous predictions. Predictive value and confirmatory value are interrelated. Information that has, predictive: value= is likely” "46" "also" have confirmatory value. For example, revenue in the current peri~onceptual Pramewor SNe = can be used to predict revenue in a future period and at the same time can also be used in confirming a past prediction Materiality “Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of a specific reporting entity's general purpose financial statements make on the basis of those financial statements.” (€0/2017/6 Definition of Material) The Conceptual Framework states that materiality is an ‘entity-specific’ aspect of relevance, meaning materiality depends on the facts and circumstances surrounding a specific entity. Accordingly, the Conceptual Framework and the Standards do not specify a uniform quantitative threshold for materiality. Materiality is a matter of judgment. IFRS? Practice Statement 2 Making Materiality Judgments provides a non-mandatory guidance that entities may follow in making materiality judgments. The guidance consists of a four- step process called the “materiality process.” Step 1 — Identify information that has the potential to be material. The starting point in making the identification is the requirements of the Standards. This is because, when developing Standards, the IASB identifies the information needs of a wide range of primary users and considers the balance between the benefits to be derived from the information and the cost of producing it. However, cost is not a factor when making materiality judgments. The entity also considers the common information needs of its primary users, in addition to those specified in the PFRSs. Step 2 — Assess whether the information identified in Step 1 is, in fact, material.46 SSS In making this assessment, the entity considers the following: , a. Whether the information could influence the users decisions, on the basis of the financial statements as a whole. The item’s nature or size, or both. c. Quantitative and qualitative factors. > Quantitative factors include the size of the impact of the item. The size of an item can be assessed in relation to q percentage of another amount (e.g., percentage of total assets or total revenues) or a threshold amount (eg, a capitalization threshold) >» Qualitative factors are characteristics of the item or its context. These are: i. Entity-specific qualitative factors, e.g., involvement of a related party or rarity of the item. ii. External qualitative factors, e.g,, the entity’s industry sector or the state of the economy. Although there is no hierarchy among materiality factors, an entity normally first assesses an item on the basis of quantitative factors. If an item is quantitatively material, the entity need not reassess it on the basis of qualitative factors. However, if an item is quantitatively not material, the entity needs to reassess it on the basis of qualitative factors, For example, an item that has a zero amount (i.¢., not quantitatively material) may nevertheless be considered material in light of qualitative factors. Step 3 — Organize the information within the draft financial statements in a way that communicates the information clearly and concisely to ) primary users. The entity exercises information in a manner that primary users, judgment on how to present maximizes understandability to thetual Framework 47 [ Step 4 — Review the draft finandal statements to delerm ine | whether all material information has been identified and | materiality considered from a wide perspective and in aggregate, | on the basis of the complete set of financial statements. The review allows the entity to ‘step-back’ and get a wider perspective of the information provided, This is necessary because an item might not be material on its own, but it might be material if used in conjunction with the other information in the complete set of financial statements. The four-step Materiality Process (IFRS? Practice Statement 2) Step 1 Requirements Knowledge about primary users’ Identity Of IFRS Standards commen information needs il ifle | ae Faithful representation . Faithful representation means the information provides a ine correct and complete depiction of the economic phenomena that it urports to represent. rep Wher an economic phenomenon’s substance differs from its legal form, faithful representation requires the depiction of the substance (i.e., substance over form). Depicting only the legal form would not faithfully represent the economic phenomenon. Faithfully represented information has the following characteristics: a. Completeness — all information (in words and numbers) necessary for users to understand the phenomenon being depicted is provided. These include description of the nature of the item, numerical depiction (e.g., monetary amount), description of the numerical depiction (e.g,, historical cost or fair value) and explanations of significant facts surrounding the item. b. Neutrality — information is selected or presented without bias, Information is not manipulated to increase the probability that users will receive it favorably or unfavorably. Neutrality is supported by prudence, which is the use of caution when making judgments under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Equally, the exercise of prudence does not allow the understatement of assets or overstatement of liabilities because the financial statements would not be faithfully represented. c. Free from error — this does not mean that the information is perfectly accurate in all respects. Free from error means there are no errors in the description and in the Process by which the information is selected and applied. If the information is an estimate, that fact should be described clearly, including an explanation of the Process used in making that estimate.ea Faithful esentation . Faithful represen means the information provides a tne correct and complete depiction of the economic phenomena that it urports to represent. rep Whee economic phenomenon’s substance differs from its legal form, faithful representation requires the depiction of the substance (i.e., substance over form). Depicting only the legal form would not faithfully represent the economic phenomenon, Faithfully represented information has the following characteristics: a. Completeness — all information (in words and numbers) necessary for users to understand the phenomenon being depicted is provided. These include description of the nature of the item, numerical depiction (e.g., monetary amount), description of the numerical depiction (e.g, historical cost or fair value) and explanations of significant facts surrounding the item. b. Neutrality — information is selected or presented without bias. Information is not manipulated to increase the probability that users will receive it favorably or unfavorably. Neutrality is supported by prudence, which is the use of caution when making judgments under conditions of uncertainty, such that assets or income are not overstated and liabilities or expenses are not understated. Equally, the exercise of prudence does not allow the understatement of assets or overstatement of liabilities because the financial statements would not be faithfully represented. c. Free from error — this does not mean that the information is perfectly accurate in all respects. Free from error means there are no errors in the description and in the Process by which the information is selected and applied. If the information is an estimate, that fact should be described clearly, including an explanation of the process used in making that estimate.Canceptual Framework 49 Enhancing qualitative characteristics Comparability Information is comparable if it helps users identify similarities and differences between different sets of information that are provided by: a. a single enti ty but in different Periods (intra-comparability); or b. different entities in a single period (inter-comparability). Unlike the other qualitative characteristics, comparability does not relate to only one item because a comparison requires at least two items, Comparison is not uniformity, meaning like things must look alike and different things must look differently. It would be inappropriate to make different things look alike, or vice versa. Although related, consistency and comparability are not the same. Consistency refers to the use of the same methods for the same items. Comparability is the goal while consistency is the means of achieving that goal. Verifiabi Information is verifiable if different users could reach a general agreement as to what the information purports to represent. Verification can be direct or indirect. Direct verification involves direct observation (eg., counting of cash). Indirect verification involves checking the inputs to a model or formula and recalculating the outputs using the same methodology (e.g., checking the debits and credits in the cash ledger and recalculating the ending balance). Timeliness Information is timely if it is available to users in time to be able to influence their decisions. Understandability Information is understandable if it is presented in a clear and concise manner.50 Understandability does not mean that complex Matters should be excluded to make information understandable to Users because this would make information incomplete and Potentially misleading. Accordingly, financial reports are intended for users. a. who have reasonable knowledge of business activities, and b. who are willing to analyze the information diligently. i Summary: Qualitative Characteristics 1. Fundamental qualitative characteristics a. Relevance (predictive value & confirmatory value) » Materiality (entity-specific aspect of relevance) b. Faithful representation (completeness, neutrality, & free from error) | 2. Enhancing qualitative characteristics | a. Comparability i b. Verifiability |G Timeliness | |___d._Understandability. Applying the qualitative characteristics The fundamental qualitative characteristics are essential to the usefulness of information; meaning, information must be both relevant and faithfully represented for it to be useful. For example, neither a relevant information that is erroneous nor a correct information that is irrelevant helps users make good decisions. The enhancing qualitative characteristics only enhance the usefulness of information that is both relevant and faithfully represented but cannot make information that is irrelevant or erroneous to be useful. Accordingly, the enhancing qualitative characteristics should be maximized to the extent possible. There is no prescribed order in applying the enhancing qualitative characteristics, Sometimes one enhancing qualitative characteristic May have to be sacrificed to maximize another, The Cost Constraint Cost is a pervasive constraint on the entity's ability to provide useful financial information.