Overview of Accounting

Definition of Accounting

Accounting is “the process of identifying, measuring, and

communicating economic information to permit informed judgment
and decisions by users of information.” (American Association of
Accountants)

Three important activities

• Identifying - the process of analyzing events and transactions to
determine whether or not they will be recognized. Only accountable
events are recognized.
• Measuring - involves assigning numbers, normally in monetary
terms, to the economic transactions and events.
• Communicating - the process of transforming economic data into
useful accounting information, such as financial statements and other
accounting reports, for dissemination to users.

Types of Events
• External events – events that involve an external party.
• Exchange (reciprocal transfer) – reciprocal giving and
receiving
• Non-reciprocal transfer – “one way” transaction
• External event other than transfer – an event that involves
changes in the economic resources or obligations of an entity
caused by an external party or external source but does not
involve transfers of resources or obligations.

2. Internal events – events that do not involve an external party.

• Production – the process by which resources are transformed
into finished goods.
• Casualty – an unanticipated loss from disasters or other similar
events.

Measurement
The several measurement bases used in accounting include, but not
limited to, the following:
• historical cost,
• fair value,
• present value,
• realizable value,
• current cost, and
 • sometimes inflation-adjusted costs.
• The most commonly used is historical cost. This is usually combined
with the other measurement bases. Accordingly, financial statements
are said to be prepared using a mixture of costs and values.

Valuation by fact or opinion

When measurement is affected by estimates, the items measured are

said to be valued by opinion.

When measurement is unaffected by estimates, the items measured are

said to be valued by fact.

Basic purpose of accounting

The basic purpose of accounting is to provide information about

economic activities intended to be useful in making economic
decisions.

Types of accounting information classified as to users’ needs

General purpose accounting information - designed to meet the

common needs of most statement users. This information is governed
by the Philippine Financial Reporting Standards (PFRSs).

Special purpose accounting information - designed to meet the

specific needs of particular statement users. This information is
provided by other types of accounting, e.g., managerial accounting, tax
basis accounting, etc.

Basic Accounting Concepts

Double-entry system – each accountable event is recorded in two

parts – debit and credit.

Going concern - the entity is assumed to carry on its operations for an

indefinite period of time.

Separate entity – the entity is treated separately from its owners.

 Stable monetary unit - amounts in the financial statements are
stated in terms of a common unit of measure; changes in purchasing
power are ignored.

Time Period – the life of the business is divided into series of reporting
periods.

Materiality concept – information is material if its omission or

misstatement could influence economic decisions.

Cost-benefit – the cost of processing and communicating information

should not exceed the benefits to be derived from it.

Basic Accounting Concepts - Continuation

Accrual Basis of accounting – effects of transactions are recognized

when they occur (and not as cash is received or paid) and they are
recognized in the accounting periods to which they relate.

Historical cost concept – the value of an asset is determined on the

basis of acquisition cost.

Concept of Articulation – all of the components of a complete set of

financial statements are interrelated.

Full disclosure principle – financial statements provide sufficient

detail to disclose matters that make a difference to users, yet sufficient
condensation to make the information understandable, keeping in mind
the costs of preparing and using it.

Consistency concept – financial statements are prepared on the basis

of accounting policies which are applied consistently from one period to
the next.

Basic Accounting Concepts - Continuation

Matching – costs are recognized as expenses when the related revenue

is recognized.

Residual equity theory – this theory is applicable where there are two
classes of shares issued, ordinary and preferred. The equation is
“Assets – Liabilities – Preferred Shareholders’ Equity = Ordinary
Shareholders’ Equity.”
 Fund theory – the accounting objective is the custody and
administration of funds.

Realization – the process of converting non-cash assets into cash or

claims for cash.
Prudence (Conservatism) – the inclusion of a degree of caution in the
exercise of the judgments needed in making the estimates required
under conditions of uncertainty , such that assets or income are not
overstated and liabilities or expenses are not understated.

Common branches of accounting

Financial accounting - focuses on general purpose financial

statements.

Management accounting – focuses on special purpose financial

reports for use by an entity’s management.

Cost accounting - the systematic recording and analysis of the costs

of materials, labor, and overhead incident to production.

Auditing - the process of evaluating the correspondence of certain

assertions with established criteria and expressing an opinion thereon.

Tax accounting - the preparation of tax returns and rendering of tax

advice, such as the determination of tax consequences of certain
proposed business endeavors.

Government accounting - refers to the accounting for the

government and its instrumentalities, placing emphasis on the custody
of public funds, the purposes for which those funds are committed, and
the responsibility and accountability of the individuals entrusted with
those funds.

Four sectors in the practice of accountancy

Practice of Public Accountancy - involves the rendering of audit or

accounting related services to more than one client on a fee basis.

Practice in Commerce and Industry - refers to employment in the

private sector in a position which involves decision making requiring
professional knowledge in the science of accounting and such position
requires that the holder thereof must be a CPA.
 Practice in Education/Academe – employment in an educational
institution which involves teaching of accounting, auditing,
management advisory services, finance, business law, taxation, and
other technically related subjects.

Practice in the Government – employment or appointment to a

position in an accounting professional group in the government or in a
government–owned and/or controlled corporation where decision
making requires professional knowledge in the science of accounting,
or where civil service eligibility as a CPA is a prerequisite.

Accounting standards in the Philippines

Philippine Financial Reporting Standards (PFRSs) are Standards

and Interpretations adopted by the Financial Reporting Standards
Council (FRSC). They comprise:
• Philippine Financial Reporting Standards (PFRSs);
• Philippine Accounting Standards (PASs); and
• Interpretations

The need for reporting standards

Entities should follow a uniform set of generally acceptable reporting

standards when preparing and presenting financial statements;
otherwise, financial statements would be misleading.

The term “generally acceptable” means that either:

• the standard has been established by an authoritative accounting
rule-making body; or
• the principle has gained general acceptance due to practice over
time and has been proven to be most useful.

The process of establishing financial accounting standards is a democratic

process in that a majority of practicing accountants must agree with a
standard before it becomes implemented.

Chapter 2
Accounting Concepts and Principles
Basic Accounting Concepts
1. Separate entity concept 7. Time Period
2. Historical cost concept 8. Stable monetary unit
3. Going concern assumption 9. Materiality concept
4. Matching 10. Cost-benefit
5. Accrual Basis 11. Full disclosure principle
6. Prudence (or Conservatism) 12. Consistency concept

Basic Accounting Concepts – (cont’n)

Separate entity concept – The business is viewed as a separate entity,

distinct from its owner(s). Only the transactions of the business are recorded
in the books of accounts. The personal transactions of the business owner(s)
are not recorded.

Historical cost concept (Cost principle) – assets are initially recorded at

their acquisition cost.

Going concern assumption – The business is assumed to continue to exist

for an indefinite period of time.

Matching – Some costs are initially recognized as assets and charged as

expenses only when the related revenue is recognized.

Accrual Basis of accounting – income is recorded in the period when it is

earned rather than when it is collected, while expense is recorded in the
period when it is incurred rather than when it is paid.

Prudence – The observance of some degree of caution when exercising

judgments under conditions of uncertainty. Such that, if there is a choice
between a potentially unfavorable outcome and a potentially favorable
outcome, the unfavorable one is chosen. This is necessary so that assets or
income are not overstated and liabilities or expenses are not understated.

Reporting Period – The life of the business is divided into series of

reporting periods.

Stable monetary unit – Assets, liabilities, equity, income and expenses are
stated in terms of a common unit of measure, which is the peso in the
Philippines. Moreover, the purchasing power of the peso is regarded as
stable. Therefore, changes in the purchasing power of the peso due to
inflation are ignored.

Materiality concept – An item is considered material if its omission or

misstatement could influence economic decisions. Materiality is a matter of
professional judgment and is based on the size and nature of an item being
judged.
Cost-benefit – The costs of processing and communicating information
should not exceed the benefits to be derived from the information’s use.

Full disclosure principle – Information communicated to users reflect a

balance between detail and conciseness, keeping in mind the cost-benefit
principle.
Consistency concept – Like transactions are accounted for in like manner
from period to period.

Philippine Financial Reporting Standards (PFRSs)

The PFRSs are Standards and Interpretations adopted by the FRSC. They
consist of the following:
• Philippine Financial Reporting Standards (PFRSs);
• Philippine Accounting Standards (PASs); and
• Interpretations

Qualitative Characteristics

Fundamental Qualitative Characteristics

i. Relevance (Predictive Value, Confirmatory Value, Materiality)
ii. Faithful Representation (Completeness, Neutrality,
Free from error)

Enhancing Qualitative Characteristics

i. Comparability
ii. Verifiability
iii. Timeliness
iv. Understandability

Fundamental vs. Enhancing

The fundamental qualitative characteristics are the characteristics that
make information useful to users.
The enhancing qualitative characteristics are the characteristics that
enhance the usefulness of information

Relevance
Information is relevant if it can affect the decisions of users.
Relevant information has the following:
 • Predictive value – the information can be used in making predictions
• Confirmatory value – the information can be used in confirming past
predictions

 Materiality – is an ‘entity-specific’ aspect of relevance.

Faithful representation

Faithful representation means the information provides a true, correct and

complete depiction of what it purports to represent.
Faithfully represented information has the following:
• Completeness – all information necessary for users to understand the
phenomenon being depicted is provided.
• Neutrality – information is selected or presented without bias.
• Free from error – there are no errors in the description and in the process by
which the information is selected and applied.

Enhancing Qualitative Characteristics

Comparability – the information helps users in identifying similarities and

differences between different sets of information.

Verifiability – different users could reach consensus as to what the

information purports to represent.

Timeliness – the information is available to users in time to be able to

influence their decisions.

Understandability – users are expected to have:

i. reasonable knowledge of business activities; and
ii. willingness to analyze the information diligently.

Chapter 3
Conceptual Framework for Financial Reporting
The Conceptual Framework sets out the concepts that underlie the
preparation and presentation of financial statements for external
users.
Authoritative Status and Applicability

The Conceptual Framework is not a PFRS. When there is a conflict

between the Conceptual Framework and a PFRS, the PFRS will prevail.

In the absence of a standard, management shall consider the

Conceptual Framework in making its judgment in developing and
applying an accounting policy that results in information that is
relevant and reliable.

The Conceptual Framework is concerned with general-purpose

financial statements.

Objective of general purpose financial reporting

The objective of general purpose financial reporting is to provide

financial information about the reporting entity that is useful to existing
and potential investors, lenders and other creditors in making decisions
about providing resources to the entity. A secondary objective of
financial statements is to show the results of the stewardship of
management.

The objective of general purpose financial reporting forms the

foundation of the Conceptual Framework. Other aspects of the
Conceptual Framework flow logically from the objective.

Users and their Needs

Primary users – those to whom general purpose financial reports are

directed:
(a) Existing and potential investors
(b) Lenders and other creditors.

Only the common needs of primary users are met by the financial
statements.

Qualitative Characteristics

I. Fundamental qualitative characteristics

(1) Relevance
(a) Predictive value
(b) Feedback value
 Materiality – entity-specific aspect of relevance
 (2) Faithful representation
(a) Completeness
(b) Neutrality
(c) Free from error

II. Enhancing qualitative characteristics

(3) Comparability
(4) Verifiability
(5) Timeliness
(6) Understandability

Elements of Financial Statements

Financial Position

Asset - resource controlled by the entity as a result of past events and

from which future economic benefits are expected to flow to the entity

Liability - 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.

Equity – assets less liabilities

Performance

Income – encompasses both (a) revenues and (b) gains

Expense – encompasses both (b) expenses and (losses)

Recognition

Recognition –the process of incorporating in the balance sheet or

income statement an item that meets the definition of an element and
satisfies the recognition criteria.

An item is recognized if all of the following are satisfied:

• The item meets the definition of an element;
• It is probable that any future economic benefit associated with the
item will flow to or from the entity; and
• The item has a cost or value that can be measured with
reliability.
Expense Recognition Principles

Direct association or matching

Systematic and rational allocation

Immediate recognition

Measurement bases
• Historical cost
• Current cost
• Realizable value (Settlement value)
• Present value

Concepts of Capital and Capital Maintenance

Financial concept of capital – capital is regarded as the invested

money or invested purchasing power. Capital is synonymous with
equity or net assets.

Physical concept of capital – capital is regarded as the entity’s

productive capacity, e.g., units of output per day.

Chapter 4
PAS 1 Presentation of Financial Statements
PAS 1 prescribes the basis for presentation of general purpose financial
statements to improve comparability both with the entity's financial
statements of previous periods (intra-comparability) and with the financial
statements of other entities (inter-comparability).

General purpose financial statements are those intended to serve

users who do not have the authority to demand financial reports
tailored for their own needs. General purpose financial statements
cater to most of the common needs of a wide range of external users.
 General purpose financial statements are the subject matter of the
Conceptual Framework and the PFRSs.

Complete set of financial statements

• Statement of financial position

• Statement of profit or loss and other comprehensive income
• Statement of changes in equity
• Statement of cash flows
• Notes
(5a) comparative information in respect of the preceding period; and
• Additional statement of financial position (required only when certain
instances occur)

General features

1. Fair Presentation and Compliance with PFRSs - The application of

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

2. Going concern - An entity is not a going concern if, as of the financial

reporting date or prior to the date of authorization of the financial
statements for issue, management either:
a. Intends to liquidate the entity or to cease trading, or
b. Has no realistic alternative but to do so.

The assessment of going concern is at least 12 months.

3. Accrual Basis of Accounting - An entity shall prepare its financial

statements, except for cash flow information, using the accrual basis of
accounting.

4. Materiality & Aggregation - Each material class of similar items must

be presented separately in the financial statements.

5. Offsetting - Assets and liabilities, and income and expenses, shall not be
offset unless required or permitted by a PFRS.
• Measuring assets net of valuation allowances, for example,
obsolescence allowances on inventories, allowances for doubtful
accounts on receivables, and accumulated depreciation on property,
plant, and equipment are not offsetting.

6. Frequency of reporting – An entity shall present a complete set of

financial statements (including comparative information) at least annually.
• When an entity changes the end of its reporting period and presents
financial statements for a period longer or shorter than one year, an
entity shall disclose the following:
• The period covered by the financial statements,
• The reason for using a longer or shorter period, and
• The fact that amounts presented in the financial statements are not
entirely comparable.

7. Comparative Information
An entity shall present comparative information in respect of the preceding
period for all amounts reported in the current period’s financial statements,
unless other standards permit or require otherwise.

8. Consistency of presentation - An entity shall retain the presentation

and classification of items in the financial statements from one period to the
next unless:
• it is apparent that another presentation or classification would be
more appropriate following a significant change in the nature of
the entity’s operations or a review of its financial statements; or
• a PFRS requires a change in presentation.

Additional Statement of financial position

• An additional statement of financial position is presented 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
• reclassifies items in its financial statements.

…..and the effect of the event to the statement of financial position as

at the beginning of the preceding period is material.

Statement of financial position

• A statement of financial position may be presented as either

• Classified – showing distinctions between current and noncurrent
assets and liabilities, or
• Unclassified (based on liquidity) – showing no distinction
between current and noncurrent items
Current Assets

An entity shall classify an asset as current when:

• it expects to realize the asset or intends to sell or consume it, in its
normal operating cycle;
• it holds the asset primarily for the purpose of trading;
• it expects to realize the asset within twelve months after the reporting
period; or
• the asset is cash or a cash equivalent unless the asset is restricted
from being exchanged or used to settle a liability for at least twelve months
after the reporting period.

Current Liabilities

An entity shall classify a liability as current when:

• it expects to settle the liability in its normal operating cycle;
• it holds the liability primarily for the purpose of trading;
• the liability is due to be settled within twelve months after the
reporting period; or
• the entity does not have an unconditional right to defer settlement of
the liability for at least twelve months after the reporting period.

Currently maturing long-term liabilities

• General rule: Currently maturing long term liabilities are presented as

current liabilities.
• Exceptions:
• Refinancing agreement is fully completed on or before the balance
sheet date – non-current liability
• Refinancing agreement after the balance sheet date but before the
financial statements are authorized for issue – noncurrent liability if the
entity expects, and has the discretion, to refinance it on a long-term basis
under an existing loan facility.

Breach of loan agreement

• General rule: A liability that is payable on demand is a current

liability.

• Exception: It is presented as non-current liability if the lender

provides the entity, on or before the balance sheet date, a grace
period ending at least 12 months after the balance sheet date to rectify
a breach of loan covenant.
Presentation of Deferred taxes

• Deferred tax liabilities (assets) are presented as noncurrent items in a

classified statement of financial position, irrespective of their expected
dates of reversal.

Minimum line items in the statement of financial position

• Property, plant and equipment;
• Investment property;
• Intangible assets;
• Financial assets (excluding amounts shown under (e), (h) and (i));
• Investments accounted for using the equity method;
• Biological assets;
• Inventories;
• Trade and other receivables;
• Cash and cash equivalents;
• Assets (or disposal groups) classified as held for sale in accordance
with PFRS 5;
• Trade and other payables;
• Provisions;
• Financial liabilities (excluding amounts shown under (k) and (l));
• Liabilities and assets for current tax, as defined in PAS 12 Income
Taxes;
• Deferred tax liabilities and deferred tax assets, as defined in PAS 12;
• Liabilities included in disposal groups classified as held for sale in
accordance with PFRS 5;
• Non-controlling interests, presented within equity; and
• Issued capital and reserves attributable to owners of the parent

Order/ Format of Presentation

PAS 1 does not prescribe the order or format in which an entity

presents items.

Statement of profit or loss and other comprehensive income

An entity shall present all items of income and expense recognized in a

period:
• in a single statement of profit or loss and other comprehensive
income; or
• in two statements: (1) a statement displaying the profit or loss section
only (separate ‘statement of profit or loss’ or ‘income statement’) and (2) a
second statement beginning with profit or loss and displaying components
of other comprehensive income.

Extraordinary items

PAS 1 prohibits the presentation of any items of income or expense as

extraordinary items in the statement(s) presenting profit or loss and
other comprehensive income or in the notes.

Other comprehensive income for the period

• Changes in revaluation surplus

• Unrealized gains and losses on investments in FVOCI securities
• Remeasurements of the net defined benefit liability (asset)
• Gains and losses arising from translating the financial statements of a
foreign operation
• Effective portion of gains and losses on hedging instruments in a cash
flow hedge

• OCI may be presented either (a) net of tax or (b) gross of tax.

Reclassification adjustments

Reclassification adjustments are amounts reclassified to profit or

loss in the current period that were recognized in other comprehensive
income in the current or previous periods.

Total comprehensive income

Total comprehensive income comprises all components of

• Profit or loss; and
• Other comprehensive income.

Presentation of Expenses

• Nature of expense method

• Function of expense method
• If an entity classifies expenses by function, it shall disclose
additional information on the nature of expenses

Disclosure of dividends

Dividends declared by an entity are disclosed either in the (a) notes or

(b) statement of changes in equity.

Order of presentation of disclosures in the Notes

• Statement of compliance with PFRSs;

• Summary of significant accounting policies applied;
• Supporting information for items presented in the other financial
statements; and
• Other disclosures.

END