CHAPTER 2

FINANCIAL ACCOUNTING AND REPORTING:

AN OVERVIEW

FINANCIAL STATEMENTS

All companies produce financial statements, the means by which

quantitative financial information and other relevant information are
communicated to the interested users. IAS 1 Presentation of Financial
Statements defines general purpose financial statements as those intended
to meet the needs of users who are not in the position to require an entity
to prepare reports tailored to their particular needs. They are the principal
means through which a company communicates its financial information
to those who have no direct access to the company’s records. The financial
statements provide information about the entity’s financial position as of
the end of the period, and the comprehensive income, cash flows, and
changes in equity for the period covered. Note disclosures are also
presented to supplement these information.

Complete Set of Financial Statements

A complete set of financial statements comprises:

1. Statement of financial position as at the end of the period. This

financial statement presents the resources controlled and the
liabilities owed by the entity, and the equity of the owners over the
business.

2. Statement of profit or loss and other comprehensive income for

the period. This financial statement provides information about
how the entity performed during a period of time, by showing the
income earned and expenses incurred. Income less expenses is
equal to profit or loss.
Chapter 2 – Financial Accounting and Reporting: An Overview

3. Statement of changes in equity for the period. This financial

statement shows the changes of owner’s interest in the business. It
is presented starting the capital at the start of the period, plus
contributions and income, less withdrawals and losses.

4. Statement of cash flows for the period. This financial statement

shows the movements of cash during a period. Movements means
inflow and outflow of cash which may be classified as operating,
financing and investing.

5. Notes, comprising significant accounting policies and other

explanatory information;

6. Statement of financial position as at the beginning of the

preceding period when an entity applies an accounting policy
retrospectively or makes a retrospective restatement of items in its
financial statements, or when it reclassifies items in its financial
statements.

These financial statements must be presented with equal

prominence in a complete set of financial statements. However, some
entities present, outside the financial statements, 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. These reports and
statements presented outside the financial statements are conversely,
outside the scope of reporting standards.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

AND STANDARD-SETTING PROCESS

Generally accepted accounting principles or GAAP, are sets of

practices developed and constantly reviewed to provide guidelines for
financial accounting and reporting. GAAP comprises the principles,

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standards, conventions and assumptions used in the preparation and

presentation of financial statements. Professional accounting bodies are
organized with main task of formulating GAAPs both internationally and
locally.

The International Accounting Standards Committee (IASC)

formed in 1973, developed accounting standards called International
Accounting Standards (IASs) which earned worldwide acceptance and
observance. World Bank, International Monetary Fund, International
Organization of Securities Commission and Organization for Economic
Cooperation and Development urged the public to adopt these set of
global accounting standards.

International Accounting Standards Board (IASB), under the

governance of the IFRS Foundation, replaced IASC in 2001. IASB
develops International Financial Reporting Standards (IFRSs). In practice,
IFRS is a collective terminology to refer to standards developed by both
IASC and IASB, including interpretations by Standing Interpretations
Committee (SIC) which was later replaced by International Financial
Reporting Interpretations Committee (IFRIC). These IFRSs or
pronouncements are adopted by a number of countries and organizations
around the world.

IFRS Foundation

IASB IFRIC

IFRSs:
1. IFRS
2. IAS
3. Interpretations
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Chapter 2 – Financial Accounting and Reporting: An Overview

In the Philippines, the body tasked to formulate accounting

standards was the Accounting Standards Council (ASC) organized by the
Philippine Institute of Certified Public Accountants or PICPA, in 1981.
ASC was composed of eight members from PICPA, SEC, BSP, BOA, and
FINEX. The body was tasked to promulgate, develop and revise
accounting standards in the Philippines. In 1997, ASC moved to adopt
IAS in the Philippines and published its version of the standard as
Philippine Accounting Standard or PAS. Later in 2005, ASC decided for
the full adoption of existing IASs by the IASC. However, prior to 1997,
the Philippines considered the issuances of US Financial Accounting
Standards Board which are called Statement of Financial Accounting
Standards or SFAS.

In 2006, Financial Reporting Standards Council (FRSC) which

was created by the Philippine Regulation Commission upon the
recommendation of the Board of Accountancy, replaced ASC. FRSC is
composed of chairman and fourteen members representing different local
agencies and organization such as BOA, SEC, BSP, BIR, COA, FINEX,
and Accredited National Professional Organizations of CPAs. FRSC’s
main task is to establish GAAP although it carried on the resolution of
ASC to converge Philippine accounting standards with International
accounting standards.

FRSC’s approved statements are Philippine Financial Reporting

Standards or PFRS. Similar to IFRS, PFRS consists of PFRS which are
adopted from IFRS, PAS which are adopted from IAS, and Interpretations
adopted from interpretations by SIC, IFRIC and the Philippines
Interpretation Committee (PIC). PIC was created by FRSC to assist the
latter in establishing and improving financial reporting standards in the
Philippines.

The formulation of accounting standards is a social process.

Considering the rapid changes in the accounting profession nowadays

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which affect the financial reporting environment, these standards are

constantly assessed and evaluated to determine if revisions are necessary.

The Qualitative Characteristics of Useful Financial Information

The qualitative characteristics of useful financial information

identify the types of information that are likely to be most useful to the
existing and potential investors, lenders and other creditors for making
decisions about the reporting entity on the basis of information in its
financial report (financial information). Qualitative characteristics are
classified into two: fundamental and enhancing.

The fundamental qualitative characteristics are relevance and

faithful representation. Whereas the enhancing qualitative characteristics
are verifiability, comparability, understandability, and timeliness.
Enhancing qualitative characteristics should be maximized to the extent
possible. However, the enhancing qualitative characteristics, either
individually or as a group, cannot make information useful if that
information is irrelevant or not faithfully represented.

Relevance is the ability of the information to influence a decision.

Relevant financial information is capable of making a difference in a
decision if it has predictive value, confirmatory value or both. Financial
information has predictive value if it can be used as an input to processes
employed by users to predict outcomes, although it need not be a
prediction or a forecast. Financial information, on the other hand, has
confirmatory value if it provides feedback (confirms or changes) about
previous evaluations.

To be useful, financial information must not only present relevant

phenomena, but it must also faithfully represent the phenomena that it
purports to represent. It should be complete, neutral and free from error.
Complete depiction includes all information necessary for a use to
understand the phenomenon being depicted, including all necessary
descriptions and explanations. A neutral depiction is without bias in the
selection or presentation of financial information. It is not slanted,

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weighted, emphasized, de-emphasized or otherwise manipulated to

increase the probability that financial information will be received
favorably or unfavorably by users. Free 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 .

Comparability is the qualitative characteristic that enables users

to identify and understand similarities in, and differences among, items.

Verifiability means that different knowledgeable and independent

observers could reach consensus, although not necessarily complete
agreement, that a particular depiction is a faithful representation.

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.

Classifying, characterizing and presenting information clearly and

concisely makes it understandable. Some phenomena are inherently
complex and cannot be made easy to understand. Excluding information
about those phenomena from financial reports might make the information
in those financial reports easier to understand. However, those reports
would be incomplete and therefore potentially misleading

The Definition, Recognition and Measurement of the Elements from

which Financial Statements are Constructed

Financial statements portray the financial effects of transactions

and other events by grouping them into broad classes according to their
economic characteristics, termed the elements of financial statements.
These elements are called assets, liability, equity, income and expense.
Assets, liabilities and equity are directly related to the measurement of

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financial position, whereas income and expenses are directly related to the
measurement of performance in the comprehensive income statement.

The Conceptual Framework defines each of these elements as

follows:

Asset is a resource controlled by the entity arising from past

transactions or events and from which future economic benefits are
expected to flow to the entity.

Liability is a present obligation of the entity arising from past

events, the settlement of which is expected to result in an outflow from the
entity of resources embodying economic benefits.

Owner’s claim or equity is the residual interest in the assets of the

entity after deducting all its liabilities

Income is increase in economic benefits during the accounting

period in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those relating to
contributions from equity participants.

Expense is decrease in economic benefits during the accounting

period in the form of outflows or depletions of assets or incurrences of
liabilities that result in decreases in equity, other than those relating to
distributions to equity participants.