FINANCIAL STATEMENTS Financial statements are the means by which the information. accumulated und processed in financial accounting is periodically communicated to the users, Financial statements are a structured financial representation of the financial position and financial performance of an entity. General purpose financial statements. General purpose financial statements are those statements intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs, Reports prepared at the request 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 statements comprises the following components: Statement of financial position Income statement Statement of comprehensive income Statement of changes in equity Statement of cash flows Notes, comprising a summary of significant accounting policies and other explanatory information Op aper Many entities also presen: reports and statements such a8 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. ts However, such statements and reports are not componen of financial statements.FINANCIAL STATEMENTS, Financial statements are the means by which the information accuntulated and processed in financial accounting is periodically communicated to the users. Financial statements are a structured financial representation of the financial position and financial performance of an entity. General purpose financial statements General purpose financial statements are those statements intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs. Reports prepared at the request 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 statements comprises the following components: Statement of financial position Income statement Statement of comprehensive income Statement of changes in equity Statement of cash flows Notes. comprising a summary of significant accounting policies and other explanatory information rere 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Obj Jective of financial statements The object ts is to pn We of general purpose financial statements Droid Ione eat nil ide mance and cash flows of an entity that is useful to “ide range of users in making economic decisions. Unancial statements also show the rests of the stewardship of management of the resources entrusted to it ‘To meet this objective, nancial statements provide information about the following: a. Assets b. Liabilities Equity a, Income and expenses, including gains and losses ¢. Contributions by and distributions to owners in their capacity as owners- f. Cash flows Such information, along with other information in the notes, would assist users of financial statements in predicting the entity's cash flows and in particular their timing and certainty. However, financial statements do not provide all the information that users may need to make economic decisions, ; financial statements largely portray the ‘The reason is that the a Francial effects of past events and do not necessarily provide nonfinancial information.Financial position ties and ‘The financial position comprises the assets, I equity of an entity at a particular moment in time. Specifically, financial position pertains to the liquidity, solvency, and the need of the entity for additional financing. This information is pictured in the statement of financial position. Financial performance ‘The financial performance comprises the revenue, expenses and net income or loss of an entity for a period of time. Performance is the level of income earned by the entity through the efficient and effective use of its resources, ‘Phe 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 voveipts 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 Finan Financial reporting i the provision of nae! information SRonknn entity to external users thats wel them in making ' eo i .ctiveness of the entity's manage paslandla aowessing the effes ‘he Principal way of providing financia} information to external s is through the annual financial statements ‘asses not only financial municating information ial accounting However, financial reporting ence statements but also other means of com that relates directly or indirectly to the finant process. Financial reports include not only financial statements but also other information such as financial highlights, summary of Ghportant Hnancal Ryures anayeisof nancial statements and significant ratios. Financial reports also include as description of major product officers and directors. nonfinancial information such ts and a listing of corporate Objective of financial reporting Under the Conceptual Framework for Financial Reporting, the ijotiveof nancial reporting ito providefinanciot information ‘entity that is useful to existing and potential about the reporting sreestors, lenders and other creditors in making decisions about providing resources to the entity the overall objective of financial reporting is Simply stated, ‘ation thal is useful for decision making. to provide inform‘Target users of financial reporting General. purpose financial reporting is directed primarily to the existing and potential investors, lenders and other creditors which compose the primary user group. ‘The reason is that existing and potential investors, lenders and other creditors have the most critical and immediate need for information in financial reports. As a matter of fact, the primary users of financial information are the parties that provide resources to the entity. Moreover, information that meets the needs of the specified primary users is likely to meet the needs of other users euch as employees, customers, governments and their agencies. ‘The management of a reporting entity is also interested in financial information about the entit However, management need not rely on general purpose financial reports because it is able to obtain or access additional financial information internally. Specific objectives of financial reporting Specifically, the Conceptual Framework for Financial Reporting states the following objectives of financial reporting: 4. To provide information useful in making investing and credit decisions about providing resources to the entity. b. ‘fo provide information useful in assessing the cash flow prospects of the entity. €. To provide information about entity resources, claims and changes in resources and claims.Limitations of financial reportin® ot and cannot 5 do n i: General purpose financial reports 49-00 vg potential Provide all of the information that oxis06 1" investors, lenders and other ereditors RO" a ag > General purpose financial reports. Fe nO eee Teports show the value of a reporting entity but these Tree Provide information to help the prim’ty the value of the entity intended to General purpose financial reports are vand cannot Provide common information to users and can accommodate every specific request for infor : te 4. Toa large extent, financial reports are based on estima and judgment rather than exact depiction Responsil lity for financial statements Fhe management of an entity has the primary responsibility for {he preparation and presentation of financial statements. The Board of Directo reviews and authorises these are submitted to va in discharging its responsibilities the financial statements for issue before the shareholders of the entity. Management is accountable for the safel keeping of the resources and their proper, efficient and prostecne, rofitable use, Shareholders are interested in informaticn that Races how effectively management hae fulnited trio toe thie ig relevant to the decision concerning those aie Fole as and the reappointment or replacement cf management General features of financial statements Fair presentation.and compliance Going concern Accrual basis Materiality and aggregation Offsetting : Frequency of reporting Comparative information Consistency of presentation with PERS ersseeNe 1Fair presentation ‘The financial statements shall present fairly the financial position, financial performance and cash flows of an entity, Virtually, in all circumstances, fair presentation is achieved if the financial statements are prepared in accordance with the Philippine Financial Reporting Standards which represent the GAAP in the Philippines ‘The application of Philippine Financial Reporting Standards, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. An entity whose finaricial statements comply with PFRS shall make an explicit and unreserved slatement 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 PERS. To present information, including accounting policies, in a manner that provides relevant and faithfully represented financial information. ¢. To provide additional disclosures necessary for the users to understand the entity's financial statements An entity cannot rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory information,Departure from standard In the concludes smely Fare circumstances in which management would be got compliance with a requirement in a standard Teauiren ce misleading, the entity shall depart from that mete Provided the relevant regulatory Conceptual depeecrt requires, or otherwise does not prohibit, such a Thus, an entity is permitted to depart from a standard: a In extremely rare circumstances. 5. When management eoneludes tht compliance with the tandard would be misleading. ©. When the departure from the standard is necessary to achieve fair presentation. d. When the regulatory Conceptual Framewor otherwise does not prohibit such a departure. pon the entity to kc requires of In such circumstances, it is incumbent 4} disclose the following: 1, The management has concluded. that the financial statements present fairly the financial position, financial performance and cash flows ofthe entity 2. ‘That the entity has complied with applicable standards except that it has departed from a particular requirement to achieve 4 fair presentation. cle ofthe standard from which the entity has departed, 3. The tfure of the departure, including the toate that, the Mandard would require, the reasen why that treatment te be 60 misleading and the treatment adopted. eriod prese 4, For each period Porn re on depereave been £2P0" Pequirement. nted, the financial impact of the the financial statements that ‘ted in complying with theGoing concern Going concern means that the accounting entity is viewed ag 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 foresceable 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. Goring 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 invends to liquidate the ontity or cease trading or has no realistic option but to do so. When upon assessment it becomes evident that there are material uncertainties regarding the ability of the entity to continue as a going concern, those uncertainties shall be fully disclosed. In making the assessment about the going concern assumption, management shall take into account all available information about the future which is at least twelve months from the end of reporting period. | If the financial statements are not prepared on & going concern basis, such fact shall be disclosed together with the measurement basis and the reason therefor. 10 @Accrual basis An eaity shall prepare the financial statements, usin scorual arin of asounting except for eas flow inane Under accrual basis, the effects of transactions », coxa ne ssogniznd when they oorur and nt aber ceca echo sand thy 8 and reported in tho financial statement of setae which they relate, eriods to 4 the simplest language, accrual basis means are reongnized when recwable eather than ae svat received, and Liabilities are rvcognized payah wwhen actually paid Payable rather than Acorual accounting menns that income is recognize carned regardless of when received and eipone Sized when when incurred regardless of when paid Sized ‘The essence of accrual accounts receivable, acct accrued expenses, deferr Accounting is tho recognition of ounts payable, prepaid expenses ‘ed income, and accrued income. Materiality and aggregation An entity shall present separately each material class of similar items. On ntity 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 le, sh on hand, petty cash fund, cash in bank od ca ene an al cat fs cot a cash equivalents’. rocess, raw materials and tranufactufing maplio are aggregated an pesca as ose uIf a Line item is not individual carey i ually material, it is elicit ac CUniet i] thane stalanionts-Gz a2 tna act For example, an investor's share in the net income of an ‘associate is presented as a separate line item in the incom However, if this amount is not individually materi be aggregated with other income. Pa asarh tind Materiality dictates that "an entity need not is provide a specifi disclosure required by PFRS if the information ‘not material” When is an item material? ‘There is no strict or uniform rule for determining whether an item is material or not. Very often, this is dependent on good judgment, professional expertise and common sense. However, a general guide may be given, to wit: An item is material if knowledge of it would affect the decision SF the informed users of the financial statements. infrmation is material if tha oninaion ox minstalonent cot nhrinos the economic decision that users make on the basis of the financial statements. For example, small expenditures for tools are often expensed immediately rather than depreciated over their useful life to save on clerical costs of recording depreciation In such a case, the effect on the financial statements is not large enough to affect economic decision. «, ies of actice of large enti Another example is the common pr 1 example ie the common practice U2 esos in rounding amounts to the nearest 1 financial statements. Small entities may round off to the nearest peso 12Materiality is relativity i in Materiality of an item depends on relative size rather thai olute ize, What is materiat for one entity may be inimaterial for another. An error multinatic eritical fo, ents of a of P100,000 in the financial statem 5 eval entity may not be important but may be si @ small entity. Factors of materiality In the exercise of judgment in determining materiality, the following factors may be considered: 8 Relative sizeof the item in relation to the total of the group '0 which the item belongs, b. Nature of the item — An item may be inherently material because by its very nature it affects economre decision, For example, the discovery of a P20,000 bribe is a material event even for a very large entity. Offsetting Assets and liabilities, and income and expenses, when material, shall not be offset against esch other. Offsetting may be done when it is required or Permitted by another PFRS. 18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 expease. 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 aet 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. ©. ‘The fact that amounts presented in the financis! statements are not entirely comparable. 14Comparable information Except when permitted or required otherwise by PFRS, an peal shall disclose comparative information in respect of the Previous period for all amounts reported in the current Period’s financial ‘statements. In other words, th hi t period Words, the financial statements of the current peri 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 itis 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 48 yet to be resolved, are disclosed in the current period. Users shall benefit from information that an uncertainty existed at the ond 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: Applies an accounting poliey retrospectively. 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 15entation Consistency of pr Implicit in the presentation of comparable information is the principle of consistency, The principle of consistency requires that the accounti ae een cnd practices shall be applied on a uniform baa from period to period. ‘The presentation and classification of financial statement tem? 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 U presentod and more relevant to the users of financial vEatoments, 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 staterients is allowed: a. When it is required by another PFRS. b. When a significant change in the nature ofthe operations of the entity will demonstrate a more appropriate presentation and classification. 1 is inappropriate for an entity to leave accounting policies nchanged when better and acceptable alternatives exist. 16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. & 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, 7PROBLEMS Problem 1-1 Multiple choice (PAS 1) A complete set of financial statements includes all of the 1 A complete set of following components, except a. Statement of financial position & Statement of changes in equity c. Notes to financial statements d. Environmental reports and value added statements 2. What is the objective of financial statements? a. To provide information about the financial position, financial performance and changes in financial position useful to a wide range of users b, To prepare a statement of financial position and statement of comprehensive income ¢ To present relevant, reliable, comparable and understandable information 4. To prepare financial statements in accordance with all applicable standards 3.The primary responsibility for the preparation of the financial statements is reposed in a. Management of the entity b. Internal auditor c. External auditor d. Controller 4: The major financial statements include all, except a. Statement of financial position Income statement ¢. Statement of cash flows 4. Statement of retained earnings 5. The major financial statements include all, except a Statement of financial position tatement of changes in financial position § Statement of comprehensive income ‘Statement of changes in equityProblem 1-2 Multiple choice (FRS) period longer or LW mt ie Then an entity changed the reporting Perr ai of the shorter than one year, an entity shall dis following, except Period covered by the financial statements. The Fr usil 1r shorter perio e reason for using a longer or shorter period c. The fact that amounts presented statements are not entirely comparable. d. The fact that similar entities in the geographical area in which the entity operates have done 60. 2, Which of the following is not a component of the financial statements? &. Statement of financial position b. Statement of changes in equity c. Report of board of directors 4. Notes to financial statements 3. Which of the following is included in a complete set of financial statements? a. A statement by the board of directors of compliance with local legislation b. A statement of changes in equity c. Statements of financial position for the last five years d. Value added statement 4, Which of the following is included within the financial statements? a. A statement of retained earnings b. Accounting policies c. An auditor's report d. Board of directors’ report 5. An entity shall clearly identify each financial statement ‘and display all of the following, except a, Name of the reporting entity. b. Names of major shareholders of the entity. ¢, The presentation currency. d. Whether the financial statements cover the individual entity or a group of entities a1Problem 1-3 Multiple choice (PAS 1) 1. Which statement is incorrect concerning fair presentation of financial statements? Fair presentation requires the faithful representation of the effvets of transactions and other events. b. Financial statements shall present fairly the financial position, financial performance and cash flows of an entity, In virtually all circumstances, a fair presentation is achieved by compliance with applicable PFRS. d. An entity whose finarcial statements comply with PERS shall not make an explicit and unreserved statement of such compliance in notes. a 2. Which of the following cannot be considered fair presentation of financial statements? a. To present information in a manner that provides relevant and faithfully represented financial information. b. To provide additional disclosures when compliance with specific PFRS is insufficient to understand the financial position and financial performance. To sclect and apply accounting policies in accordance with applicable PFRS. 4. To rectify inappropriate accounting policies cither by disclosure of the accounting policies used or by notes or explanatory information. 3. Which statement indicates a going concern? a, Management intends to liquidate the entity. b. Management intends to cease the operations of the entity. Management has no realistic alternative but to cease the operations of the entity. 4. None of these would indicate going concern 224. An entity is permitted to depart from a particular standard if ull of the following conditions are satisfied, except In extremely rare circumstances. When management concludes that compliance with the standard would be misleading, When the departure from the standard is necessary to achieve fair presentation, 4. When the Conceptual Framework for Financial Reporting prohibits such a departure. 5. The effects of transactions and other events on economic resources and claims aro depicted in the periods in which those effects occur even if the resulting cash receipts and payments occur in a different period. a, Accrual accounting b. Cash accounting ¢. Modified accrual accounting d. Modified cash accounting 6. Financial statements must be prepared at least a. Annually b Quarterly c. Semiannually d. Fvery two years 7 Technically, offsetting in financial statements is accomplished when a. The allowance for doubtful accounts is deducted from accounts receivable. b. The accumulated depreciation is deducted from property, plant and equipment. ¢. The total Fiabilities are deducted from total assets, 4. Gain or lose from disposal of noncurrent asset is reported by deducting from the proceeds the carrying amount of the asset and the related disposal cost. 23&.The presentation and classification of items in the Financial statoments shall be retained from one accounting period to the next, ‘a. Consistency of presentation b. Materiality cc. Aggregation a. Comparability 9, A third statement of financial position as at beginning of the earliest comparative period presented is required a. When an entity applies an accounting policy retrospectively. b. When an entity makes a retrospective re items in the financial statements. When an entity reclassifies items in statements. d. Under all of these circumstances statement of ce the financial 10, Which statement in relation to financial statements in incorrect? nancial statements do not and a. General purpose fi {f the information that primary cannot provide all of users need. 1b. General purpose financial statements are designed to show the value of the reporting entity. ¢, General purpose financial statements are intended to provide common information to users, 4. Financial statements are largely based on estimate and judgment rather than exact depiction. 24Problem 1-4 Multiple choice (IFRS) 1. Items of dissimilar nature or function & Must always be presented separately. Must not be presented separately. ¢ Must be presented separately if material. = —_ Must be presented separately even if immaterial. 2. Materiality depends on a. The nature of the omission or misstatement. b. The absolute size of the omission or misstatement. c. The relative size and nature of the omission or misstatement judged in the surrounding circumstances. a. The judgment of management. 3. An entity must disclose comparative information for 8. The previous comparable period for all amounts. ». The previous comparable period for all amounts and for all narrative and descriptive information. c. The previous comparable period for all amounts and for all narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. d. The previous two comparable periods for all amounts. 4. When the classification of items in the financial statements is changed, the entity a. Must not reclassifiy the comparative amounts. b. Can choose whether or not to reclassify. c. Must reclassify the comparative amounts unless it is impracticable to do so. 4. Must reclassify the current year amounts only. 5. An entity shall present a. The statement of cash flows more prominently. b. ‘The statement of financial position more prominently. c. The income statement more prominently. 4. Each financial statement with equal prominence. 25Problem 1-5 Multiple choice (IAA) 1. The overall objective of financial reporting is to provide information fa. ‘That is useful for decision making b. About assets, liabilities and equity c. About financial performance during a period 4. That assesses performance of management 2, The objective of financial reporting is based on The need for conservatisin Reporting on management stewardship Generally accepted accounting principles ‘The needs of the users of the information as oe 3. Which is an objective of financial reporting? a. Ta provide information that is useful in making investing and credit decisions, b. To provide information that is useful to management. ¢. To provide information to investors. d. To provide information about internal and external conflicts, 4. Which is an objective of financial reporting? a. To provide information useful to management. b. To identify nonfinancial transactions, c. To provide information useful to assess the amount, timing and uncertainty of prospective cash receipts. d. To provide information that excludes claims. 5. An objective of financial reporting is to provide a. Information about the investors in the entity. b. Information about the liquidation value of the entity: ©. Information useful in assessing cash flow prospects 4. Information that. will attract new investors. 26Problem 1-6 Multiple choice (AICPA Adapted) 1, During a period when an entity is under the direction of ‘a particular management, financial reporting will directly provide information about a. Entity performance and management performance >. Management performance but not entity performance c. Entity performance but not management performance a. Neither entity nor management performance 2, Financial reporting pertains to a. Individual business entities, rather than to industries or an economy or to members of society as consumers b. Individual business entities and an economy or to members of society as consumers ©. Individual business entities and an economy rather than to industries or to consumers 4. Individual business entities, industries and an economy rather than to members of society as consumers 3. Which is not an objective of financial reporting? a. Financial reporting shall provide information about resources, claims against resources and changes in them b. Financial reporting shall provide information useful in evaluating stewardship of management. c. Financial reporting shall provide information useful in investment, credit and similar decision. 4. Financial reporting shall provide information useful in assessing cash flow prospects. 4. Which is not an objective of financial reporting? 4. To provide information about assets and claims against those assets ». To provide information useful in assessing cash flows ©. To provide information useful in lending and investing decisions 4. To provide information about the liquidation value of an entity 27Problem 1-7 Multiple choice (IAA) i c financial 1. Which would likely prepare the most accurate forecast for an entity based on empirical evidence? a. Investors using statistical models b. Corporate management c. Financial analysts d. Independent certified public accountants 2 What is the most useful information in predicting future cash flows? Information about current cash flows Current earnings based on accrual accounting Information regarding the accounting policies used Information regarding the results obtained by using a wide variety of accounting policies pore 8. The accrual basis of accounting is most useful for a. Determining the amount of income tax liability. b. Predicting short-term financial performance. ¢ Predicting long-term financial performance. d. Determining the amount of dividends to shareholders, 4. In measuring financial performance, acerual accounting is used because a. Cash flows are considered less important. b. It provides @ better indication of ability to generate cash flows than cash basis. c. It recognizes revenue when cash is received and expenses when cash is paid. d. It is one of the implicit assumptions, 5. The financial statements prepared under GAAP Do not articulate with one another. lect a single measurement which is historical cost. Are not highly precise because estimate and judgment must be made. 4. Contain a limited number of future projections. a b. ©,