Calamba Review Center - Laguna (LCRC)

2F MMCO Building, 8000 Lakeview Ph3 Angela Street, Halang, Calamba City Laguna, Philippines
Tel No. (02) 330-8617, (049) 523-6031; (02) 330-6057
CPA REVIEW (May 2020 Batch)
FAR Cedrick Zapanta, CPA

Financial Accounting and Reporting

May 2020 Batch
Module 1

1. Overview of Accounting
2. Accounting Standard-setting Process and Institutions
3. Conceptual Framework

OVERVIEW OF ACCOUNTING

1. History of Accounting
Historical records show that the beginnings of record keeping or storing information dates back some 76,000 years ago in the
Blombos caves of Africa.

Accounting In Ancient Egypt, China, Greece and Rome

• Government accounting records in Egypt show “in kind” tax payments.
• China used Accounting as a means of evaluating the efficiency of governmental programs
• Legislation on financial matters in Greece (5th century BC) included control of receipts and expenditures of public
monies through the oversight of “public accountants” chosen by lot
• In its thousand years of existence, these records showed simple list-making only, similar to single-entry bookkeeping
• Early financial records in the Roman Empire include the Account, (listed public revenues); the Treasury, (which listed
amounts of cash in the provincial tax officials and in the hands of the public contractors). The records included not
only cash and commodities but also the names of freed men and slaves, especially the records Roman army.
• Medieval Europe (13th century) –introduction of double-entry bookkeeping. The chief objective was to keep track of
amounts owed by customers (debtors) and amounts owed to creditors. Debit is Latin for 'he owes' and credit is Latin
for 'he trusts'.
• The Messari (Italian for Treasurer’s accounts, of the city of Genoa 1340) is the oldest discovered record of a complete
double-entry system. These accounts contain debits and credits journalized in a bilateral form.

Luca Pacioli and Double-entry System of Bookkeeping

• Luca Pacioli's "Summa de Arithmetica, Geometria, Proportioni et Proportionalità," published in Venice in 1494,
included a 27-page, 36 short chapters on bookkeeping.
• Books of accounts used by Luca Pacioli
o The memorandum (a daybook) – for chronological recording of business transactions as they occurred
o The journal – the merchant's private account book
o The ledger – the money and date columns were almost identical to those in modern ledgers, with entries
consisting of brief paragraphs
• The trial balance is the end of Pacioli's accounting cycle. Debits from the old ledger are listed on the left side of the
balance sheet and credits on the right. If the two totals are equal, the old ledger is considered balanced. If not (in
balance), says Pacioli, "that would indicate a mistake in your ledger, which mistake you will have to look for diligently with the industry
and intelligence God gave you."
• The objective of Luca Pacioli’s keeping records is to give traders prompt information as to his assets and liabilities.
• The Summa is the first known printed treatise on bookkeeping and was translated into different languages. It is widely
believed to be the forerunner of modern bookkeeping practice.
• Thus, it can be said that Luca Pacioli systematized record keeping through the double-entry bookkeeping system.

Professional Accountancy Travels across the Globe

• 1880: Institute of Chartered Accountants in England and Wales (ICAEW) brought together all the accountancy
organizations in those countries
• 1887: the first national accounting society of the United States was formed, the American Association of Public
Accountants (predecessor of the AICPA)

Accounting in the Internet Era

• The act of accounting is usually defined as the act of collecting information on resource usage for the purpose of trend
analysis, auditing, billing, or cost allocation.
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 o For example when a user uses a connectivity service paid with a pay-per-view approach the accounting process
is based on a metering of the resource usage by the user (usually time spent with an active connection or the
amount of data transferred using that connection). The accounting is hence the recording of this connectivity
service consumption for subsequent charging of the service itself.

Recent Trends and Developments in Accounting

• Cloud Accounting
• Automation (Artificial Intelligence)
• Data Analytics
• Environmental Accounting
• Standardization and Harmonization

2. Definition, Nature, and Purpose of Accounting

Definition: Accounting is a service activity. Its function is to provide quantitative information, primarily financial in nature,
about economic entities that is intended to be useful in making economic decisions.

Accounting is the art of recording, classifying, summarizing in a significant manner and in terms of money, transactions and
events which are, in part at least, of a financial character and interpreting the results thereof.

Nature:
• Accounting as Science and Art – Accounting is a social science with a body of knowledge which has been systematically
gathered, classified, and organized. It is influenced by, and interacts with, economic, social and political environments.
Accounting is a practical art which requires the use of creative skill 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.

Purpose: To provide quantitative information1 about economic entities2 intended to be useful in making economic decisions.

1 – Types of information provided by accounting

• Quantitative information – expressed in numbers, quantities or units
• Qualitative information – expressed in words or descriptive form
• Financial information – expressed in terms of money

2 – Economic entity vs business entity

• Economic entity – is a separately identifiable combination of persons and property that uses or controls economic or
scarce resources to achieve certain goals or objectives. Scarce resources have one significant characteristic: because of
their limited nature, they command a price.
o Business entity is an economic entity that produces and distributes goods or services primarily for profit.
o Not-for-profit or non-profit entity is one that carries out some socially desirable needs of the community or its
members whose activities are not directed towards making profit.

3. Functions of Accounting
a. Identification – the accounting process of recognition or non-recognition of business activities as “accountable events”
or whether they have accounting relevance.
b. Measurement – the accounting process of assigning of peso amounts or numbers to the economic transactions and events.
The unit of measure of accounting is money, expressed in prices.
c. Communication – the accounting process of preparing and distributing accounting reports to potential users of accounting
information and interpreting the significance of this processed information. The three aspects of communicating are:
i. Recording – the process of systematically committing to writing business transactions and events in books of
account in a systematic and chronological manner according to accounting rules and regulation.
ii. Classifying – the grouping of similar and interrelated items into their respective classes.
iii. Summarizing – expressing in condensed or brief form the recorded and classified information in financial
statements.

4. Branches of Accounting
a. Financial Accounting – the recording of transactions, preparation of financial statements and communication of financial
information to external user groups. (Focus: general purpose reports)
b. Auditing – the examination of financial statements by independent certified public accountant for the purpose of expressing
an opinion on the fairness of presentation of financial statements. (Focus: audit report)
c. Management Accounting (or Management Services) – the accumulation and communication of information for use by
internal parties or management. This includes services to clients on matters of accounting, finance, business policies,
organization procedures, product costs, distribution, and many other phases of business conduct and operations. (Focus:
advisory services; consultancy)
d. Government Accounting – accounting for the national government and its instrumentalities, focusing attention on the
custody of public funds and the purpose or purposes to which such funds are committed.
e. Tax Accounting – involves the preparation of tax returns and rendering of tax advice, such as determination of tax
consequences of certain proposed business endeavors. (Focus: Tax advisory services)

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 f. Fiduciary Accounting – handling of accounts managed by a person entrusted with the custody and management of property
for the benefit of another.
g. Social Responsibility Accounting – reporting of programs and projects that have to do with the upliftment of the welfare
of the people of a community or of the nation.
h. Environmental Accounting – the area of accounting that focuses on programs, activities and projects that are focused on
care for Mother Earth. One example is carbon accounting which is a process of encouraging reductions in greenhouse gas
emissions.
i. Price-level Accounting (Accounting for Hyperinflationary Economies) – is accounting that recognizes in the financial
statements changes in the purchasing power of money. This is in contrast to traditional accounting which assumes a stable
monetary unit when it reports financial information.

5. Financial Accounting vs. Management Accounting

Financial Accounting Management Accounting
o Basically concerned with income o Basically concerned with decision-
determination and asset valuation making
o Prepares statements in accordance with o Prepares statements in accordance
GAAP with management needs
o Prepares general purpose statements o Prepares special purpose reports for
that can be used by external and internal users
internal users
o Historical in nature o Future-oriented
o Emphasizes objective data o Makes use of subjective data as long as
it is relevant

6. Areas of Professional Accounting Practice

a. Public Accounting – composed of individual practitioners, accounting firms and large multinational organizations that
render independent expert financial services to the public on a professional fee basis. Public accountants usually offer three
kinds of services: assurance and audit, taxation, and management advisory services.
b. Private Accounting – composed of individuals employed in business enterprises on salary basis. The major objective of
private accounting is to assist management in planning and controlling the enterprise’s operations.
c. Government Accounting – composed of accountants employed in the different branches of government, such us the BIR,
COA, SEC, and GBEs. The focus of government accounting is custody and administration of public funds.
d. Accounting Education – composed of CPAs who are professors of accounting in various colleges and universities. Their
task is to prepare entrants into the accountancy profession.

7. Environment of Accounting
Financial accounting is shaped to a significant extent, by the environment, and in particular, all of the following:
• The economic activities in society
• The means of measurement of economic activity
• The financial statement users and their information needs

Accountable Events – are events that are quantifiable and has an effect on assets, liabilities and equity. Also known as economic
activities, these are the subject matter of accounting.
• Only economic activities are emphasized and recognized in accounting. Sociological and psychological matters are not
recognized.
• Criteria for an accountable event
o It must affect a financial element of accounting (increasing or decreasing asset, liability or equity (probability
criterion)
o It is a result of a past activity
o Its cost can be measured reliably (measurability criterion)

Types of Accountable Events

1. External Events – events wherein another party participates
a. Transfers – there is flow of economic resources
i. Exchanges – two-way
ii. Non-reciprocal Transfers – one-way
b. External Events other than Transfers – no flow of economic resources
2. Internal Events – those wherein only the entity participates
a. Production
b. Casualties

QUIZZER – OVERVIEW OF ACCOUNTING

History of Accounting
1. Are the following statements about the history of Accounting true or false?
I. According to the history of accounting, debit means “he owes” and “credit” means “he trusts”.
II. Frater Luca Bartolomes Pacioli did not invent accounting but his treatise, “De Computis et Scripturis is said to
have laid the foundation for double-entry bookkeeping as it is practiced today.
III. The earliest accounting records date back to the 14th Century and were found in the Roman Empire.
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 Statement I Statement II Statement III
a. True False True
b. False True False
c. True True False
d. False False True

2. Which of the following statements pertaining to Luca Pacioli’s bookkeeping system is (are) true?
I. The books of accounts included a Memorandum, a journal and a ledger.
II. The objective of Luca Pacioli’s keeping records is to give traders prompt information as to his assets and liabilities.
III. Luca Pacioli’s accounting cycle is basically the same as the accounting cycle as practiced today.
a. Statements I and II are true c. Statements II and III are true
b. Statements I and III are true d. All statements are true

3. Which of the following statements is (are) true?

I. Accountancy is a communication service profession.
II. Financial accounting is the process of identifying, measuring, analyzing, and communicating financial information
needed by management to plan, evaluate, and control an organization's operations.
III. Financial statements are the principal means through which financial information is communicated to those outside
an enterprise.
a. Statements I and II only c. Statements II and III only
b. Statements I and III only d. Statements I, II and III

4. Which of the following statements is not an objective of financial reporting?

a. Provide information on the liquidation value of an enterprise.
b. Provide information that is useful in assessing cash flow prospects.
c. Provide information that is useful in investment and credit decisions.
d. Provide information about enterprise resources, claims to those resources, and changes to them.

5. In which of the following situations is the science aspect of accounting demonstrated?

I. The accountant makes use of the rules of debit and credit in recording transactions of the business.
II. Transactions and events are processed using the steps of the accounting cycle.
III. A provision for doubtful accounts was estimated by the accountant on the basis of recorded data and the collection
experience of the company.
a. I only c. II and III only
b. I and II only d. I, II, and III

6. The art aspect of accounting is applied in which of the following circumstances?

I. The accountant records a purchased equipment at cost plus expenses in acquisition and putting it available for use.
II. The external auditor gives an unqualified opinion that the financial statements are fairly presented in conformity
with generally accepted accounting principles.
III. The accountant selects the reliable fair value at which a consumable biological asset will be recognized and
measured in the books of account.
a. Statement I only c. Statements II and III
b. Statements I and II d. Statements I, II, and III

7. Which of the following statements is (are) true?

I. Not all quantitative information is also financial in nature.
II. Measurement is the process of assigning numbers to objects such as inventories or plant assets and to events such
as purchases or sales.
III. Management decisions are oriented to the future whereas the decisions of external users are oriented to the past.
a. I and II only c. I and III only
b. II and III only d. I, II, and III

8. Which of the following features of an asset closely links its definition to the science of Economics?
a. An asset is controlled by an entity c. An asset can command a price
b. An asset can provide future benefits to an entity d. An asset is exclusively owned by an entity
9. Which of the following is not an economic entity?
a. Lee, Min & Ho Associates, a law office c. Polytechnic University of the Philippines
b. ABCD Group of Companies d. Janet, a Filipino citizen who owns JLN Piggery
10. Which of the following is an economic entity but not a business entity?
a. Golden Acres, a charitable institution c. Rustan’s supermarket
b. Consolidated Foods Corporation d. ABC Co., a stock corporation
Events and Transactions / Accountable Events
11. These are events and transactions that affect the enterprise and in which other entities participate.
a. External events c. Exchange transactions
b. Internal events d. Production

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12. These are events in which only the entity participates
a. External event c. Non-reciprocal event
b. Internal events d. Accountable event

13. These are reciprocal transfers of resources or obligations between the enterprise and other entities in which the enterprise
either sacrifices resources or incurs obligations in order to obtain other resources or satisfy other obligations
a. Exchanges c. Manufacturing
b. Production d. Investment

14. These are changes in economic resources by actions of other entities that do not involve transfers of enterprise resources
and obligations
a. Transfers c. Internal events
b. External events other than transfers d. Production

15. Some events involve the transfer of resources in only one direction, either from the enterprise to other entities, or from
other entities to the enterprise. These are called
a. Nonmonetary transactions c. Nonreciprocal transfers
b. Arms-length exchanges d. Executory contracts

16. External events are those that affect the enterprise and in which other entities participate. One example is when
a. A manufacturing company transfers goods from one production department to another
b. The expired portion of prepaid insurance is taken up as expense
c. Loss of inventory due to fire
d. Issuance of promissory note in settlement of an account
17. The following are classified as external events except
a. Payment of money borrowed c. Government grant
b. Purchase of supplies d. Casualty loss
18. Safe Corp. discovered a material amount of loss from theft. The value of the loss should be classified as
a. A non-reciprocal transfer c. An exchange
b. A reciprocal transfer d. A casualty

19. Which of the following is (are) classified as external events other than transfers?
I. Exchange of assets with no commercial substance
II. Transfer of materials from one stage of production to another
III. Technological changes caused by other entities
IV. General price level changes
a. I and II only c. II, III and IV only
b. III and IV only d. I, III and IV only

20. Which of the following criteria should be met before a particular action, condition, or set of circumstances qualifies as an
accountable event?
a. It has already happened.
b. It affects the financial position of individual business entities.
c. It can be measured in monetary terms with a reasonable degree of precision.
d. All of the above
Users of Accounting Information
21. The investors or providers of risk capital and their advisers are concerned with the following information except
a. The need to determine whether they should buy, hold, or sell their investment
b. The need to assess the ability of the enterprise to pay dividends
c. The need to assess the ability of the enterprise to provide retirement benefits and employment opportunities
d. The need to assess the risk inherent in, and return provided by their investments

22. Customers are interested in information

a. That enables them to determine whether amounts owing to them will be paid when due
b. About the continuance of an enterprise, especially when they have long-term involvement with or are dependent on
the enterprise
c. About the stability and profitability of the enterprise
d. To regulate the activities of the enterprise

23. Lenders are interested in information that enables them to determine

a. Whether the entity has the capacity to pay its short-term obligation
b. Whether their loans and the interest attaching to them will be paid when due
c. Whether the enterprise is making a substantial contribution to the local economy
d. Whether the enterprise will continue to operate as a going concern

24. Which of these statements about users of financial information is (are) true?
I. The public need information about the trends and recent developments in the prosperity of the enterprise

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 II. Employees and their representative groups are interested in information about the stability and profitability of the
enterprise
III. The providers of risk capital and their advisers are concerned with the risk inherent in and return provided by their
investments
IV. Government and their agencies have an interest in information about the continuance of an enterprise, especially
when they have long-term involvement or are dependent on the enterprise
a. Only I is true c. I, II, and III are true
b. I and II are true d. All statements are true

The next five (5) items pertain to ethical issues, some procedures and practices by Sara Corp. For each of the situations described
in these numbers, identify what assumption, principle, qualitative objective or constraint is violated
25. Sara Corporation switched from accelerated depreciation method to straight line method because the company's income
is low this year
a. Comparability c. Understandability
b. Neutrality d. Relevance

26. The president of Sara Corp. believes it is foolish to report financial information on a yearly basis. Instead, the president
believes that financial information should be disclosed only when significant new information is available related to the
company's operations.
a. Going Concern c. Periodicity
b. Economic Entity d. Money measurement

27. Sara Corp. decides to establish a large loss and related liability this year because of the possibility that it may lose a
pending patent infringement lawsuit. The possibility of loss is considered remote by its attorneys
a. Measurement Principle c. Revenue recognition Principle
b. Matching Principle d. Disclosure Principle

28. An officer of Sara Corp. purchased a new home computer for personal use with company money, charging this to
miscellaneous expense.
a. Materiality c. Relevance
b. Economic or separate entity d. Verifiability

29. A bookkeeper discovered an omitted sales invoice of P500 while she was preparing the draft financial statements the year.
Since the total sales for the year amount to P5,000,000, she did not correct the error anymore as she reasoned that the
amount anyway is not material. This is
a. An application of the materiality concept
b. A violation of the materiality concept
c. An application of the initial recognition principle
d. A violation of the initial recognition principle

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 CONCEPTUAL FRAMEWORK OF FINANCIAL ACCOUNTING

Definition: A conceptual framework is a coherent system of interrelated basic concepts and propositions that prescribe objectives,
limits, and other fundamentals of financial accounting and serves as a basis for developing and evaluating accounting principles and resolving accounting
and reporting controversies (FASB).

Preface to the Philippine Financial Reporting Standards

1. Institutions, Professional Bodies and Standard-Setting Due Process
The FRSC
The Financial Reporting Standards Council (FRSC) was established by the Board of Accountancy (BOA or the Board) in 2006
under the implementing Rules and Regulations of the Philippine Accountancy Act of 2004 to assist the Board in carrying out its
power and function to promulgate accounting standards in the Philippines.

Composition: Appointed by BOA

A Chairman and members that include sectoral representatives from the Philippine Institute of Certified Public Accountants
(PICPA), the Board of Accountancy, the Securities and Exchange Commission, (SEC), Bangko Sentral ng Pilipinas (BSP),
Financial Executives Institute of the Philippines (FINEX) and Philippine Institute of Certified Public Accountants (PICPA),
Commission on Audit (COA) and Bureau of Internal Revenue (BIR)

The FRSC is the successor of the Accounting Standards Council (ASC), which was created on November 18, 1981 by the
Philippine Institute of Certified Public Accountants to establish generally accepted accounting principles in the Philippines.

Responsibility of FRSC: The approval of Philippine Financial Reporting Standards (PFRSs), Philippine Interpretations and
related documents such as the Framework for the Preparation and Presentation of Financial Statements, exposure drafts, and
other discussion documents.
• Once it was established, the FRSC resolved that all Standards and Interpretations issued by the ASC continue to be
applicable unless and until they are amended or withdrawn by the FRSC.
• The Philippine Interpretations Committee (PIC) was formed by FRSC in November 2006 to assist the FRSC in
establishing and improving financial reporting standards in the Philippines. The role of the PIC is principally to issue
implementation guidance on PFRSs. The PIC replaced the former Interpretations Committee created by the ASC in
2000.

Objectives of the FRSC:

(1) The main function of the FRSC is to establish generally accepted accounting principles in the Philippines. In achieving
the objective the FRSC considers Standards issued by the IASB.
(2) The FRSC carries on the decision made by the ASC to converge Philippine accounting standards and international
accounting standards issued by the IASB. The objectives of FRSC in this respect are:
a) To develop, in the public interest a single set of high quality, understandable and enforceable accounting standard
that require, high quality, transparent and comparable information in financial statements and other financial
reporting to help participants in the various capital markets and other users of the information to make economic
decisions
b) To promote the use and rigorous application of those standards; and
c) To work for the convergence of Philippine accounting standards with international Financial Reporting Standards
(PFRSs) issued by the IASB.

Scope and Authority of PFRSs

1) The FRSC issues its Standards in a series of pronouncements called Philippine Financial Reporting Standards
(PFRSs). These consist of:
(a) Philippine Financial Reporting Standards (PFRSs) (these correspond to the International Financial Reporting
Standards (IFRSs)
(b) Philippine Accounting Standards (PASs) (these correspond to International Accounting Standards (IASs); and
(c) Philippine Interpretations (these correspond to Interpretations of the IFRIC and the Standing Interpretations
Committee (SIC) of the IASC. (These also include Interpretations developed by the PIC)

2) The FRSC achieves its objectives primarily by developing and issuing Philippine Financial Reporting Standards (PFRSs)
and promoting the use of these standards in general purpose financial statements and other financial reporting.

3) PFRSs sets out the recognition, measurement, presentation and disclosure requirements dealing with transactions and
events that are important in general purpose financial statements. They may also set out such requirements for the
transactions and events that arise mainly in specific industries. The Framework also provides a basis for the use of
judgment in resolving accounting issues.

4) PFRSs are designed to apply the general purpose financial statements and other financial reporting of all profit-oriented
entities. Profit-oriented entities include those engaged in commercial, industrial, financial and similar activities, whether
organized in corporate or any other forms. They include organizations such as mutual insurance companies and other
mutual cooperative entities that provide dividends or other economic benefits directly and proportionately to their
owners, members or participants. Although PFRSs are not designed to apply to not-for profit activities in private sector,
public sector or government, entities with such activities may find them appropriate

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 5) PFRSs apply to all general purpose financial statements. These financial statements are directed towards the
common information needs of a wide range of users, for example, shareholders, creditors, employees and the public at
large.

The objective of financial statements is to provide information about the financial position, performance and cash flows of an entity
that is useful to those users in making economic decisions.

6) A complete set of financial statements include a statement of financial position (or balance sheet), a statement of
comprehensive income , a statement showing either all changes in equity or changes in equity other than those arising
from capital transactions with owners and distribution to owners, a cash flow statement, and accounting policies and
explanatory notes.

7) Interpretations of PFRSs are intended to give authoritative guidance on issues that are likely to receive divergent or
unacceptable treatment in the absence of such guidance.

Philippine Due Process in Accounting Standard-Setting

PFRSs are developed through a due process that includes members of PICPA, financial executives, regulatory authorities,
academics, and other interested individuals and organizations. Due process for projects normally, but not necessarily includes
the following steps:
a) Consideration of pronouncements of the IASB;
b) Formation of a task force, when deemed necessary, to give advice to the FRSC;
c) Issuing for comment an exposure draft approved by a majority of the FRSC members, comment period will be at least
60 days unless a shorter period (not less than 30 days) is considered appropriate by FRSC.
d) Consideration of all comments received within the comment period and, when appropriate, preparing a comment letter
to the IASB; and
e) Approval of the standard or an interpretation by a majority of the FRSC members.
f) Approval of the Standard by majority of the members of the Board of Accountancy.
g) Final approval of the Accounting standard or Interpretation by the Professional Regulation Commission
h) Publication in the PRC Official Gazette

FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF FINANCIAL STATEMENTS

CONCEPTUAL FRAMEWORK

1. Purpose and Status

The FRSC Framework for the Preparation and Presentation of Financial Statements identifies the following purposes:
a) Assists the FRSC in the development of future Philippine Financial Reporting Standards and its review of existing
Philippine accounting standards.
b) Assists preparers of financial statements in applying the Statements of Financial Accounting Standards and in dealing with
topics that have yet to form the subject of a Philippine Financial Reporting Standard
c) Assists auditors in forming an opinion as whether financial statements conform with Philippine Financial Reporting
Standards.
d) Assists users of financial statements in interpreting the information contained in financial statements prepared in
conformity with Philippine Financial Reporting Standards, and
e) Provides those who are interested in the work of FRSC with information about its approach to the formulation of
Statements of Philippine Financial Accounting Standards.

This framework is not a PFRS. However, when developing an accounting policy in the absence of a standard or an
Interpretation that specifically applies to an item, an entity’s management is required to refer to, and consider the applicability
of the concepts of the Framework. (see PAS 8, Accounting Policies, Changes in Accounting Estimates and Errors).

In a limited number of cases where there may be a conflict between the Framework and the requirements within the Standard
or Interpretation, the Standard or Interpretation should prevail over those of framework.

2. Scope
1) The framework deals with:
(a) The objective of financial statements:
(b) The qualitative characteristics that determine the usefulness of information in financial statements.
(c) The definition, recognition and measurement of the elements from which financial statements are constructed;
and
(d) Concepts of capital and capital maintenance

A complete set of financial statements normally include:

• A statement of financial position
• A statement of comprehensive income
• A statement of changes in financial position (which could be presented in many ways, like a statement of cash flows), and

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 • Those notes and other statements and explanatory material that are an integral part of the financial statements. They may
also include supplementary schedules and information based on, or derived from and expected to be read with such (ex:
financial information about industrial and geographical segment, and disclosures about the effects of changing prices.

3. Special purpose financial statements are outside of the scope of this Framework.

4. Applicability: Financial statements of all commercial, industrial, and business reporting enterprises whether public or private
sector. A reporting enterprise is an enterprise for which there are users who rely on the financial statements as their major
source of financial information about the enterprise.

5. Users and their Information Needs

Users of the financial statements have different needs for the information which are as follows:
a. Investors – The provider of risk capital and their advisers are concerned with the risk inherent in, and return provided by
their investments. They need information:
• to help them determine whether they should buy, hold or sell
• to assess the ability of the enterprise to pay dividends
b. Employees – Employees and their representative groups need information about the stability and profitability of their
employers. They need information that will enable them:
• to assess the ability of the enterprise to provide remuneration, retirement benefits and employment opportunities.
c. Lenders – Lenders are interested in the information that enables them:
• to determine whether their loans, and the interest attaching to them will be paid when due.
d. Suppliers and other trade creditors – They are interested in information that enable them:
• to determine whether the amounts owing to them will be paid when due.
• Trade creditors are likely to be interested in an enterprise over a shorter period of time than lenders unless they are
dependent upon the continuation of the enterprise as a major customer.
e. Customers – They need information that enable them to:
• to know about the continuance of the enterprise, especially when they have a long term involvement with, or are
dependent on, the enterprise.
f. Government and their agencies – They are interested in the allocation of resources and activities of the enterprise. They
require information:
• to regulate the activities of the enterprises,
• to determine taxation policies and as the basis for national income and similar statistics.
g. Public – Enterprises affect the members of the public in a variety ways. For example the enterprises may make a substantial
contribution to the local economy in many ways, including the number of people they employ and their patronage of the
local suppliers. The public need financial statements in order to assists them
• to determine trends and recent developments in the prosperity of the enterprise and the rank of its activities.

The basic financial statements are designed to meet the common needs of all users. As investors are providers of risk
capital to the enterprise, the provision of financial statements that meet their needs will also meet most of the needs of
other users.

6. Responsibility for the Financial Statements

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

7. Objective of Financial Statements

The objective of financial statements is to provide information about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic decisions.
Financial statements prepared for this purpose:
• Meet the common needs of most users.
• Also show the results of the stewardship of management, or accountability of management for the resources entrusted
to it.
• Do not, however provide all the information that users may need to make decisions since they largely portray the
financial effects of past events and do not necessarily provide non-financial information.

A. Financial position – The financial position of an enterprise is affected by the economic resources it controls, its financial
structure, it liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates. This is primarily
provided in the Statement of Financial Position (or Balance Sheet). It answers the following questions:
• What assets does the entity own?
• What does it owe?
• What are the residual equity interests in the entity’s net assets?

Other important information provided by the statement of financial position are as follows:
• Financial structure – is the source of financing for the assets of the enterprise. It indicates what amount of assets has
been financed by creditors, which is borrowed capital, and what amount of assets has been financed by owners, which
is invested capital.

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 Significance: (1) Useful in predicting future borrowing needs and how future profits and cash flows will be distributed
among those with an interest in the enterprise
(2) Useful in predicting how successful the enterprise is likely to be raising further finance.
• Liquidity – refers to the availability of cash in the near future after taking account of financial commitments over this
period.
Significance: Useful in predicting the ability of the enterprise to meet its short-term financial commitments as they
fall due
• Solvency – refers to the availability of cash over the longer term to meet financial commitments as they fall due
Significance: Useful in predicting the ability of the enterprise to meet its long-term financial commitments as they
fall due
• Capacity for adaptation – the ability of the enterprise to use its available cash for unexpected requirements and
investment opportunities. This is also known as financial flexibility. It can be accomplished by raising cash at a short
notice either through borrowing or issuance of securities or by disposal of assets without disrupting normal operations.
Significance: Information about the economic resources controlled by the enterprise and its capacity for adaptation
is useful in predicting the ability of the enterprise to generate cash and cash equivalents in the future

B. Financial performance reflected by accrual accounting

Performance of an enterprise – comprises its revenue, expenses, net income or loss for a period of time. It is the level of
income earned by the enterprise through efficient and effective use of its resources. Information about the performance of an
enterprise, in particular its profitability, is important in assessing potential changes in the economic resources that it is likely to
control in the future. Information about performance is primarily provided in a statement of comprehensive income.

Accrual accounting recognizes transactions and other events of a reporting entity in the periods in which those effects occur,
even if the resulting cash receipts and payments occur in a different period.

Current financial reporting standards provide that all increases and decreases in equity other than from owner – related
transactions, that is, income, expense, realized and unrealized gains and losses should be reported in the overall performance
report.

Changes in financial position – refers to the changes in the economic resources and obligation of an enterprise. In
constructing a statement of changes in financial position, funds can be defined in various ways, such as all financial resources,
working capital, liquid assets or cash. .

Information about changes in financial position is provided in the financial statement by means of a separate statement.
Significance: (1) Useful in assessing investing, financing and operating activities during the reporting period.
(2) Useful in providing the user with a basis to assess the ability of the enterprise to generate cash and cash
equivalents and the needs of the enterprise to utilize those cash flows.

Fundamentally related financial statements – The component parts of the financial statements interrelate because they reflect
different aspects of the same transactions or other events. Although each statement provides information that is different from
the others, none is likely to serve only a single purpose or provide all the information necessary for particular needs of users.
Notes and Supplementary Schedules
The financial statements also contain notes and supplementary schedules and other information. For example, they may contain
additional information that is relevant to the needs of users about the items in the balance sheet and income statement. They
may include:
• Disclosures about risks and uncertainties affecting the enterprise and
• Any resources and obligations not recognized in the balance sheet (mineral reserves)
• Information about geographical and industry segments and the effect on the enterprise of changing prices

Qualitative Characteristics of Financial Statements

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness
of financial information is enhanced if it is comparable, verifiable, timely and understandable.

A. Fundamental Qualitative Characteristics

The fundamental qualitative characteristics are
1. relevance and
2. faithful representation

(1) Relevance
Relevant financial information is capable of making a difference in the decisions made by users. Information has the quality of
relevance when it influences the economic decisions of users by helping them to evaluate, past, present, or future events or
confirming, or correcting, their past evaluations.

Financial information is capable of making a difference in decisions if it has predictive value or confirmatory value, or both.
(a) Predictive value - Financial information has predictive value if it can be used as an input to processes employed
by users to predict future outcomes. Thus, the information can help users increase the likelihood of correctly predicting or
forecasting outcome of events. For instance, information about financial position and past performance is frequently used
in predicting dividend and wage payments, and the ability of the enterprise to meet maturing commitments
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 (b) Confirmatory value (or feedback) - Financial information has confirmatory value if it provides feedback about
(confirms or changes) previous evaluations. Information with feedback value enables users to confirm or correct
expectations.
The predictive value and confirmatory value of financial information are interrelated.

Materiality
Materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the
information relates in the context of an individual entity’s financial report. Materiality provides a threshold or cut-off point rather
than being a primary qualitative characteristic which information must have to be useful. The relevance of information is affected
by its nature and materiality. Information is material if its omission or misstatement could influence the economic decisions.

(2) Faithful Representation

Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only
represent relevant phenomena, but it must also faithfully represent the phenomena that it purports to represent.

Characteristics of faithful representation:

a) Completeness - A complete depiction includes all information necessary for a user to understand the event or
information being presented, including all necessary descriptions and explanations.
b) Neutrality - A neutral presentation of information is one without bias. A neutral information is one that is not
manipulated to increase the probability that financial information will be received favorably or unfavorably by users.
c) Freedom from error - means there are no errors or omissions in the description of the phenomenon, and the process
used to produce the reported information has been selected and applied with no errors in the process.

Faithful representation does not mean accurate in all respects. In this context, free from error does not also mean perfectly
accurate in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or
inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being
an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and
applying an appropriate process for developing the estimate.

B. Enhancing Qualitative Characteristics

The usefulness of information that is relevant and faithfully represented is enhanced by the qualitative characteristics of
comparability, verifiability, timeliness and understandability
(1) Comparability - is the qualitative characteristic that enables users to identify and understand similarities in, and
differences among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A
comparison requires at least two items.

Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one
reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar
information about other entities and with similar information about the same entity for another period or another date.

Consistency, is not the same as comparability. Consistency refers to the use of the same methods for the same items, either from
period to period within a reporting entity or in a single period across entities.

Comparability is the goal; consistency helps to achieve that goal.

(2) Verifiability – means that different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation. Verifiability helps assure users that
information faithfully represents the economic phenomena it purports to represent.

Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct
observation, for example, by counting cash. Indirect verification means checking the inputs to a model, formula or other
technique and recalculating the outputs using the same methodology.

(3) Timeliness – means having information available to decision-makers in time to be capable of influencing their decisions.
Generally, the older the information is the less useful it is. However, some information may continue to be timely long after
the end of a reporting period because, for example, some users may need to identify and assess trends.

(4) Understandability – means classifying, characterizing, and presenting information clearly and concisely. Some phenomena
are inherently complex and cannot be made easy to understand. However, excluding this information from the financial
reports may render these reports be incomplete and therefore potentially misleading.

Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who
review and analyze the information diligently. At times, even well-informed and diligent users may need to seek the aid of
an adviser to understand information about complex economic phenomena.

C. Cost Constraint
Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information
imposes costs, and it is important that those costs are justified by the benefits of reporting that information.

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Providers of financial information expend most of the effort involved in collecting, processing, verifying and disseminating
financial information, but users ultimately bear those costs in the form of reduced returns. Users of financial information also
incur costs of analyzing and interpreting the information provided. If needed information is not provided, users incur additional
costs to obtain that information elsewhere or to estimate it.

In applying the cost constraint, there is a need to assess whether the benefits of reporting particular information are likely to
justify the costs incurred to provide and use that information.

VI. The Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according
to their economic characteristics. These are termed the elements of financial statements. Elements directly related to
measurement of financial position are Assets, Liabilities and Equity while elements directly related to measurement of
performance are Income and Expenses.

The statement of changes in financial position usually reflects income statement elements and changes in balance sheet elements;
accordingly, this Conceptual Framework identifies no elements that are unique to this statement. The presentation of these
elements in the balance sheet and the income statement involves a process of sub-classification. For example, assets and liabilities
may be classified by their nature or function in the business of the entity in order to display information in the manner most
useful to users for purposes of making economic decisions.

QUIZZER – CONCEPTUAL FRAMEWORK

The IASB, FASB, FRSC AND “DUE PROCESS”

1. The IASB conceptual framework is intended to establish
a. Generally accepted accounting principles in financial reporting by business enterprises
b. The meaning of “present fairly in accordance with generally accepted accounting principles”
c. The objectives and concepts for use in developing standards of financial accounting and reporting
d. The hierarchy of sources of generally accepted accounting principles.

2. The purpose of the International Accounting Standards Board is to

a. Issue enforceable standards which regulate the financial accounting and reporting of multinational companies
b. Develop a uniform currency in which the financial transactions of companies throughout the world would be
measured
c. Develop a single set of high quality IFRS.
d. Arbitrate accounting disputes between auditors and international companies

3. Which of these statements regarding the IFRS and US GAAP is correct?

a. US GAAP is considered to be “principles-based” and more detailed than IFRS
b. US GAAP is considered to be “rules-based” and less detailed than IFRS
c. IFRS is considered to be “principles-based” and less detailed than US GAAP
d. Both US GAAP and IFRS are considered “rules-based”, but US GAAP tends to be more complex

4. Which of the following is not included in the scope of the IASB’s conceptual framework?
a. Qualitative characteristics of useful financial accounting information
b. Definition, recognition & measurement of the elements
c. Concepts of capital and capital maintenance
d. Generally accepted accounting principles

The Financial Reporting Standards Council

5. The main function of this body is to establish and improve accounting standards that will be generally accepted in the
Philippines
a. Board of Accountancy
b. Philippine Institute of CPAS
c. Professional Regulation Commission
d. Financial Reporting Standards Council

6. You are given the following statements relating to the FRSC and standard setting process in the Philippines. Which of
these is (are) true?
I. All members of the FRSC should be CPAs.
II. The Financial Reporting Standards Council (FRSC) Board of Accountancy (BOA) and Professional Regulation
Commission (PRC) are all involved in the standard setting process, with PRC as the final approving authority.
a. Only I is true c. I and II are true
b. Only II is true d. I and II are false

7. Which of the following is a characteristic of the Financial Reporting Standards Council (FRSC)?
a. FRSC members must come from CPA firms
b. FRSC members are required to render service on full-time basis
c. All four sectors of the Accountancy profession are represented in the FRSC

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 d. All members should be CPAs

8. Once the FRSC has established an accounting standard

a. The standards are continually reviewed to see if modifications or amendments are necessary
b. The standards are not reviewed unless the SEC makes a complaint
c. The task of reviewing the standard to see if modification is necessary is given to PICPA
d. The standard should never be modified to conform with the principle of consistency

Nature/Purpose/Scope
9. A conceptual framework is
a. An International Financial Reporting Standard
b. An underlying accounting assumption
c. A theoretical foundation which guides the accounting standard-setters, the prepares and users of financial
accounting information in the preparation and presentation of financial statements
d. A financial statement

10. Which is not a basic purpose of a conceptual framework?

a. Assist preparers of financial statements in applying FRSC accounting standards
b. Assist accounting standard-setting body in reviewing and adopting International Accounting Standards
c. Assist accounting standard setting body in developing accounting standards
d. Assist the Board of Accountancy in promulgating rules and regulations affecting the practice of accountancy in the
Philippines

11. A soundly developed conceptual framework of concepts and objectives should

a. Increase financial statement users’ understanding of and confidence in financial reporting
b. Enhance comparability among companies’
c. Allow new and emerging practical problems to be more quickly solved
d. All of the above

12. In the conceptual framework for financial reporting, what provides the “why” – the goals and purposes of accounting?
a. Measurement and recognition concepts such as assumptions principles and constraints
b. Qualitative characteristics of accounting information
c. Elements of financial accounting
d. Objective of financial reporting

13. The underlying theme of the conceptual framework is

a. Decision usefulness c. Reliability
b. Understandability d. Comparability

14. The accounting standard setting body in the Philippines is currently known as
a. The Accounting Standards Council
b. The Financial Reporting Standards Council
c. The Auditing Standards and Practices Council of the Philippines
d. The Auditing and Assurance Standards Council

Users of Financial Information

15. Which users need financial information to enable them to assess the ability of the enterprise to pay dividends?
a. Employees c. Suppliers
b. Lenders d. Investors

16. Which users need financial information to assess trends and recent developments in the prosperity of an enterprise?
a. Customers c. Government & their agencies
b. Public in general d. Employees

17. Which of the following financial statement users need to determine whether obligations due them, usually over a short
period of time, will be paid when due?
a. Employees c. Suppliers and other trade creditors
b. Lenders d. Customers

18. Which of the following users will need financial information to regulate activities of an enterprise and determine taxation
policies?
a. Lenders c. Management
b. Government and their agencies d. Public

19. Which of the following statement users will use financial information to anticipate price changes, seek alternative sources
of supply, and assess ability of enterprise to operate as a going-concern?
a. Public in general c. Lenders
b. Customers d. Employees

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20. Which of the following statement users need to determine whether the obligations due them for loans granted and the
related interest will be paid when due?
a. Lenders c. Suppliers and other trade creditors
b. Customers d. Investors

21. Which users need financial information to enable them to assess the ability of the enterprise to provide remuneration and
retirement benefits and employment opportunities?
a. Employees c. Customers
b. Government and its agencies d. Investors

Basic Features/Assumptions of Accounting

22. According to FRSC Conceptual Framework, the following may be considered among the basic features of accounting
that have a direct relationship with preparation and presentation of financial statements.
a. Accounting Entity and Time Period c. Going Concern and Exchange Price
b. Accrual and Going Concern d. Timeliness and Neutrality

23. Clarence, Inc. is a company whose securities are traded on over-the-counter market. It controls Sherwin Corp.
Consolidated financial statements are prepared in recognition of the accounting concept of
a. Economic entity c. Legal entity
b. Materiality d. Flexibility

24. The following statements relate to basic assumptions of financial accounting. Which is false?
a. An enterprise is not viewed as a going concern if liquidation appears imminent.
b. The life of an enterprise is divided into equal time segments at the end of which financial statements are prepared.
c. The basic financial statements contain the same underlying data and made use of the same measurement rules, and
are therefore fundamentally related.
d. Financial accounting measurements are primarily based on current values.

25. This assumption states that the determination of periodic income and financial position depends on the measurement of
economic resources and obligations and changes in them as the changes occur rather than simply on receipt or and
payments of cash.
a. Accrual c. Monetary unit
b. Going concern d. Time period

26. When a parent company and subsidiary relationship exists, consolidated financial statements are prepared in recognition
of
a. Legal entity c. Stable monetary unit
b. Economic entity d. Time period

27. Which underlying concept serves as the basis for preparing financial statements at regular intervals of time?
a. Accounting entity c. Accounting period
b. Going concern d. Stable monetary unit

28. Past experience indicates that continuation of operations is highly probable for most enterprises although continuation
cannot be known with certainty.
a. Going concern c. Periodicity
b. Accounting entity d. Monetary unit

29. The accounting function is to account for nominal pesos only and not for changes in purchasing power
a. Accrual c. Separate entity
b. Monetary unit d. Time period

30. The concept that justifies the classification of assets and liabilities in the balance sheet as to current and non-current is
a. Going concern c. Monetary postulate
b. Accounting entity d. Periodicity

Basic Financial Statements

31. The general objective of financial statements is
a. To provide financial information to assist users make economic decisions
b. To disclose the market value of the firm’s assets and liabilities
c. To determine compliance with tax laws
d. To make forecasts about the economy

32. It is generally referred to as the financial flexibility of an enterprise.

a. Liquidity c. Financial structure
b. Solvency d. Capacity for adaptation

33. It is the level of income earned by an enterprise through efficient and effective utilization of resources.
a. Financial position b. Performance

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 c. Positive cash flows d. Negative cash flows

34. This statement shows information about the operating, investing and financing activities of the enterprise during a period
of time.
a. Statement of Receipts and Disbursements c. Statement of Cash Flows
b. Statement of Financial Position d. Statement of Changes in Owner’s Equity

35. This refers to the availability of cash over a long term to meet financial commitments when they fall due.
a. Liquidity c. Financial flexibility
b. Solvency d. Financial structure

36. This indicates what amount of assets has been financed by creditors (borrowed capital) and how much has been financed
by owners (equity/invested capital).
a. Solvency c. Financial position
b. Financial structure d. Financial flexibility

37. Which of the following statements about the financial statements is true?
a. A prediction of events and transactions that will give rise to cash inflows and cash outflows is best seen in the
Statement of Cash Flows.
b. A statement of Comprehensive Income shows only realized gains and losses for the period.
c. The Statement of Changes in Equity shows information about owner-related transactions and events as well as
results of profit – directed activities including realized and unrealized gains and losses for a time-period.
d. Notes to financial statements are necessary because there are significant transactions and events that are non-
quantifiable but are important in making economic decisions.

Qualitative Objectives/Constraints
38. Which of the following is not considered a qualitative objective of financial accounting or aspect of these objectives?
a. Objectivity c. Consistency
b. Freedom from bias d. Conservatism

39. Comparability of financial information depends on

a. b. c. d.
Consistency Yes Yes No No
Regular reporting periods No Yes No Yes

40. It is the capacity of information to make a difference in decision by helping users form predictions about outcome of
past, present and future events or conform and correct prior expectations.
a. Relevance c. Comparability
b. Understandability d. Reliability

41. Which of the following is (are) the quality of information that assures readers that the information is representationally
faithful?
a b. c. d.
Freedom from error Yes No Yes No
Freedom from bias Yes Yes No No
Completeness Yes No No Yes

42. It is the ability to bring together for the purpose of noting similarities and dissimilarities.
a. Relevance c. Understandability
b. Reliability d. Comparability

43. Some accounting measures are more easily verified than others. Which of the following is the least verifiable measure?
a. Cost of machinery c. Salaries paid for the period
b. Amount of cash d. Net realizable value of accounts receivable

44. Objectivity is assumed to be achieved when an accounting transaction

a. Is recorded in a fixed amount of pesos
b. Involves the payment or receipt of cash
c. Involves an arm’s length transaction
d. Allocate revenues or expenses in a rational manner

45. The consistency standard of reporting requires that

a. Expenses are charged against the period in which they are incurred.
b. Whenever there is a change in an accounting method from one that was previously used by an enterprise, such
change must be justifiable and must be disclosed in the financial statements.
c. Extraordinary gains and losses should not appear in the income statement
d. Accounting procedures be adopted which give a consistent rate of net income

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46. Which of the following is the threshold of recognition as to what information is relevant to be displayed in the balance
sheet or the income statement
a. Materiality c. Prudence
b. Timeliness d. Understandability

47. What is meant by comparability when discussing financial information?

a. Information has predictive or feedback value
b. Information is reasonably free from error
c. Information that is measured and reported in similar fashion across companies
d. Information is timely

48. What is meant by consistency when discussing financial accounting information?

a. Information that is measured and reported in a similar fashion across points in time.
b. Information is timely
c. Information is measured similarly across the industry
d. Information is verifiable

49. Which of the following is not a proper condition for comparability within a single enterprise?
a. The contents of the statements are identical
b. Accounting principles should not be changed, or if they are changed, the financial effects need not be disclosed.
c. The presentation of the financial statements in the same form
d. Changes in the circumstances or in the nature of underlying transactions are disclosed.

50. Financial reporting is concerned only with information that is significant enough to affect evaluation or decision.
a. Timeliness c. Materiality
b. Cost and benefit d. Comparability

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