FINANCIAL STATEMENTS

Financial statements are the means by which the information accumulated

and processed in financial accounting is periodically communicated to the users.

Financial statements are a structure financial representation of the financial position

and financial performance of an entity.

General purpose financial statements

General purpose financial statements are those statements intended to meet the
needs of users who are not in position to require an entity to prepare reports tailored to
their particular information needs.

Reports prepared at the requests of an entity’s management or bankers are not general
purpose financial statements because they are prepared specifically to meet the needs
of management or bankers.

COMPONENTS OF FINANCIAL STATEMENTS

A complete set of financial statement comprises the following components:
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of significant accounting policies and other
explanatory information

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

However, such statements and reports are not components of financial statements.

OBJECTIVE OF FINANCIAL STATEMENTS

The objective of general purpose financial statement is to provide information about
the financial position, financial performance and cash flows of an entity that is useful
to a wide range of users in making economic decisions.

Financial statements also show the results of the stewardship of management of the
resources entrusted to it.

To meet this objective, financial statements provide information about the

following:
A. Assets
B. Liabilities
C. Equity
D. Income and expenses, including gains and losses
E. Contributions by and distributions to owners in their capacity as owners
F. Cash flows
Such information, along with other information in the notes, would assist users of
financial statements in predicting the entity’s cash flows and in particular their timing
and certainty.

However, financial statements do not provide all to information that users may need t
make economic decisions.

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

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

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

This information is pictured in the statement of financial position.

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

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

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

portrayed in the income statement and statement of comprehensive income.

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

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

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

FINANCIAL REPORTING
Financial reporting is the provision of financial information about an entity to external
users that is useful to them in making economic decisions and for assessing the
effectiveness of the entity’s management.

The principal way of providing financial information to external users is through the
annual financial statements.

However, financial reporting encompasses not only financial statements but also
other means of communicating information that relates directly or indirectly to the
financial accounting process.
Financial reports include not only financial statements but also other information
such as financial highlights, summary of important financial figures, analysis of
financial statements and significant ratios.

Financial reports also include nonfinancial information such as description of major

products and listing of corporate officers and directors.

Objective of financial reporting

Under the Conceptual Framework of Financial Reporting, the objective of financial

reporting is to provide financial information about the reporting entity that is useful to
existing and potential investors, lenders and other creditors in making decisions about
providing resources to the entity.

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

that is useful for decision making.

Target users of financial reporting

General purpose financial reporting is directed primarily yo the existing and potential
investors, lenders and other creditors which compose the primary user group.

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

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

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

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

the entity.

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

Specific objectives of financial reporting

Specifically, the Conceptual Framework of Financial Reporting states the following
objectives of financial reporting:
A. To provide information useful in making investing and credit decisions about
providing resource to the entity.
B. To provide information useful in assessing the cash flow prospects of the entity.
C. To provide information about entity resource, claims and changes in resources and
claims.

Limitations of financial reporting

a. General purpose financial reports do not and cannot provide all of the information
that existing and potential investors, lenders and other creditors need.
b. General purpose financial reports are not designed to show the value of a reporting
entity but these reports provide information to help the primary users estimate the
value of the entity.
c. General purpose financial reports are intended to provide common information to
users and cannot accommodate every specific request for information.
d. To a large extent, financial reports are based on estimate and judgement rather han
exact depiction.

Responsibility for financial statements

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

The Board of Directors in discharging is responsibilities reviews and authorizes the

financial statements for issue before these are submitted to the shareholders of the
entity.

Management is accountable for the safekeeping of the resources and their proper,
efficient and profitable use.

Shareholders are interested in information that helps them assess how effectively
management has fulfilled this role as this is relevant to the decision concerning their
investment and the reappointment or replacement of management.

General features of financial statement

1. Fair presentation and compliance with PFRS
2. Going concern
3. Accrual basis
4. Materiality and aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation

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

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

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

The application of Philippine Financial Reporting Standards, with additional

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

An entity whose financial statements comply with PFRS shall make an explicit and
unreserved statement of such compliance in the notes.
Fair presentation is defined as faithful representation of the effects of transactions and
other events in accordance with the definitions and recognition criteria for assets,
liabilities, income and expenses laid down in the Conceptual Framework.

Fair presentation requires an entity:

A. To select and apply accounting policies in accordance with PFRS.
B. To present information, including accounting policies, in a manner that provides
relevant and faithfully represented financial information.
C. To provide, additional disclosure necessary for the users to understand the entity’s
financial statements

An entity cannot rectify inappropriate accounting policies either by disclosure of

the accounting policies used or by notes or explanatory information.

Departure from standard

In the extremely rare circumstances in which management concludes that
compliance with a requirement in a standard would be so misleading, the entity shall
depart from that requirement provided he relevant regulatory Conceptual Framework
requires, or otherwise does not prohibit, such a departure.

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

A. In extremely rare circumstances
B. When management concludes that compliance with the standard would be
misleading
C. When the departure from the standard is necessary to achieve fair presentation
D. When the regulatory Conceptual Framework requires of otherwise does not
prohibit such a departure.

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

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

Going concern
Going concern means that the accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary

Going concern is also known as continuity assumption

In other words, financial statements are prepared normally on the assumption that the
entity shall continue in operation for the foreseeable future.
Thus, assets are normally recorded at original acquisition cost. As a rule, market
values are ignored

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

Going concern is particularly relevant when management shall make an estimate of

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

This postulate is the very foundation of the cost principle

Financial statements shall be prepared on a going concern basis unless management

intends to liquidate the entity or cease trading or has no realistic option but to do so

When upon assessment it becomes evident that there are material uncertainties
regarding the ability of the ability of the entity to continue as a going concern, those
uncertainties shall be fully disclosed

In making the assessment about the going concern assumption, management shall take
into account all available information about the future which is at least twelve months
from the end of reporting period

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

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

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

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

Accrual accounting means that income is recognized when earned regardless of when
received and expense is recognized when incurred regardless of when paid

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

payable, prepaid expenses, accrued expenses, deffered income, and accrued income

Materiality and aggregation

An entity shall present separately each material class of similar items

An entity shall present separately items of dissimilar nature or function unless they
are immaterial
Financial statements result from processing large number of transactions or other
events that are aggregated into classes according to their nature or function
The final stage in the process of aggregation and classification is the presentation of
condensed and classified data which form line items in the financial statements

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

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

If a line item is not individually material, it is aggregated with other items either in
those statements or in the notes

For example, an investor’s share in the net income of an associate is presented as a

separate line item in the income statement

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

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

What is an item material?

There is no strict or uniform rule for determining whether an item is material or not

Very often, this is dependent on good judgement, professional expertise and common
sense

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

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

Information is material if the omission or misstatement could influence the economic

decision that users make on the basis of the financial statements

For example, small expenditure for tools are often expensed immediately rather than
depreciated over their useful life to save on clerical costs of recording depreciation

In such a case, the effect on the financial statements is not large enough to affect
economic decision

Another example is the common practice of large entities of rounding amounts to the
nearest thousand pesos in their financial statements

Small entities may round off to the nearest peso

Materiality is a relativity
Materiality of an item depends on relative size rather than absolute size
What is material for one entity may be immaterial for another

An error of P100,000 in the financial statements of a multinational entity may not be

important but may be so critical for a small entity

Factors of materiality
In the exercise of judgement in determining materiality, the following factors may be
considered:

A. Relative size of the item in relation to the total of the group to which the item
belongs
For example, the amount of advertising in relation to total distribution costs, the
amount of office salaries to total administrative expenses, the amount of prepaid
expenses to total current assets and the amount of leasehold improvements to total
property, plant and equipment.

B. Nature of the item- an item may be inherently material because by its very nature it
affects economic decision
For example, the discovery of a P20,000 bribes is a material event for a very large
entity

Offsetting

Asses and liabilities, and income and expenses, when material, shall not be offset
against each other

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

Examples of offsetting
Gains and losses on disposal of noncurrent assets are reported by deducting from the
proceeds the carrying amount of the assets and the related selling expenses

Expenditure related to a provision and reimbursed under a contractual arrangement

with a third party may be netted against the related reimbursement

In other words, the expenditure related to a provision and any reimbursement from a
third party can be offset, and only the net expenditure is presented as expense

In addition, gains and losses arising from a group of similar transactions are reported
Examples of offsetting

Gains and losses on disposal of noncurrent assets are reported by deducting from the
proceeds the carrying amount of the assets and the related selling expenses.

Expenditure related to a provision and reimbursed under a contractual arrangement

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

In addition, gains and losses arising from a group of similar transactions are reported
on a net basis.
For example, foreign exchange gains and losses or gains and losses arising from
trading securities are netted against the other.

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

The measurement of assets net of valuation allowance is permitted because

technically this is not offsetting.

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

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

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

a. The period covered by the financial statements.

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

Comparable information

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

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

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

Comparative information shall be included for narrative and descriptive information

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

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

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

Third statement of financial position

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

a. Applies an accounting policy retrospectively.

b. Makes retrospective restatement of items in the financial statements.
c. Reclassifies items in the financial statements.
Under these circumstances, an entity shall present three statements of financial
position as at:

1. The end of the current period

2. The end of the previous period

3. The beginning of the earliest comparative period

Consistency of presentation

Implicit in the presentation of comparable information is the principle of consistency.

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

The presentation and classification of financial statement items shall be uniform from
one accounting period to the next.

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

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

Consistency is desirable and essential to achieve comparability of financial

statements.

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

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

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

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

allowed:
a. When it is required by another PFRS.
b. When a significant change in the nature of the operations of the entity will
demonstrate a more appropriate revised presentation and classification.

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

and acceptable alternatives exist.

Identification of financial statements

Financial statements shall be clearly identified and distinguished from other

information in the same published document.
Each component of the financial statements shall be clearly identified.
In addition, the following information shall be prominently displayed:

a. The name of the reporting entity.

b. Whether the financial statements cover the individual entity or a group of entities.

c. The end of the reporting period or the period covered by

the financial statements or notes.

d. The presentation currency.

e. The level of rounding used in the amounts in the financial statements.

Financial statements are often made more understandable by presenting information

in thousands or millions of units of the presentation currency.

This is acceptable as long as the level of rounding in presentation is disclosed and

relevant and material information is not lost or omitted.