Ae 17 Module 1 and 2
Ae 17 Module 1 and 2
Module 1 to provide financial information about the reporting entity that is useful to
existing and potential investors, lenders, and other creditors in making decisions
Lecture Guide 1 : Review of the Conceptual Framework for Financial Reporting and about providing resources to the entity. This information is about the economic
The Accounting Process resources and claims and changes in resources and claims; and
to show the results of management’s stewardship over economic resources The
Conceptual Framework for Financial Reporting economic resources and claims are reported in the Statement of Financial
describes the objective and concept for general purpose financial statements. Position or Balance Sheet. The changes in resources and claims related to
provides guidance for the standards in developing future standards. financial performance can be found in the Statement of Comprehensive Income.
not a PFRS, in case of conflict between conceptual framework and accounting The changes in the entity’s cash flows can be found in Statement of Cash Flows.
standard, requirement of accounting standard prevails. The changes in resources and claims not related to financial performance can be
found in the Statement of Changes in Equity.
Scope of the Conceptual Framework
Chapter 1 : Objective of Financial Reporting Qualitative Characteristics of Useful Financial Information
Chapter 2 : Qualitative Characteristics of Useful Information Fundamental Qualitative Characteristics
Chapter 3 : The Financial Statements and The Reporting Entity 1. Relevance – An information is considered relevant if knowledge of such would
Chapter 4 : Elements of Financial Statements influence the decision or evaluation of user.
Chapter 5 : Recognition and Derecognition a. Predictive Value
Chapter 6 : Measurement b. Confirmatory value
Chapter 7 : Presentation and Disclosure
Chapter 8 : Concepts of Capital and Capital Maintenance 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.
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arise from other rights. For example, Liwayway Corp. acquires a car through bank
Going Concern Assumption financing. Although the bank retains title over the car until full payment, the car is an
Financial statements presume that an entity will continue in operation indefinitely or asset of the Liwayway Corp because Liwayway Corp has the exclusive right to use the
if that presumption is not valid, disclosure and a different basis of reporting are car and controls the benefit from it.
required.
Physical possession is also not always necessary for control to exist. For example,
The Elements of Financial Statements goods transferred by a principal to an agent on consignment remain as assets of the
1. Assets principal until the goods are sold to third parties. This is because the principal retains
2. Liabilities control over the goods even though physical possession is transferred to the agent.
3. Equity
4. Income Liability is a present obligation of the entity to transfer an economic resource as a
5. Expenses result of past events. For a liability to exist, three criteria must all be satisfied :
1. the entity has an obligation
Asset is “a present economic resource controlled by the entity because of past events. 2. the obligation is to transfer an economic resource
An economic resource is a right that has the potential to produce economic benefits” 3. the obligation is a present obligation that exists as a result of past events
(Framework 4.3) Rights that have the potential to produce economic benefits include :
1. Rights that correspond to an obligation of another party. An obligation is a duty or responsibility that an entity has no practical ability to avoid.
a. right to receive cash, goods, or services It is always owed to another party who could be a person or another entity.
b. right to exchange economic resources with another party on favorable terms
c. right to benefit an obligation of another party to transfer an economic Equity is the residual interest in the assets of the enterprise after deducting all the
resource if a specified uncertain future event occurs. liabilities. In other words, they are claims against the entity that do not meet the
2. Rights that do not correspond to an obligation of another party. definition of liability. In a corporate structure, capital is raised through issuance of
a. right over physical objects (e.g., right to use a property or right to sell an shares. Ordinary shares are the same as common stocks. Preference shares – also
inventory) known as preferred stocks has the preference over the ordinary shares on the income
b. right to use intellectual property of the corporation. For a partnership, its equity is called partners’ equity and for sole
proprietorship, owner’s equity.
An economic resource can produce economic benefits for an entity in many ways. It
may be : Income is the increase in assets or decreases in liabilities that result in increases in
1. sold, leased, transferred or exchanged for other assets equity other than those relating to contributions from equity owners.
2. used singly or in combination with other assets to produce goods or provide
services Expenses is the decrease in assets or increases in liabilities that result in decreases in
3. used to enhance the value of other assets equity other than those relating to contributions from equity owners.
4. used to promote efficiency and cost savings
5. used to settle a liability Recognition
An item is classed as “recognized” when it is included in the financial statements
Control normally stems from legally enforceable rights (ownership or legal title).
However, ownership is not always necessary for control to exist because control can
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To be classed as “recognized”, an item should both meet the definition of an c. The measurement requires exceptionally difficult or exceptionally subjective
element and satisfies the criteria for recognition, i.e. providing useful (relevant allocations of cash flows that do not relate solely to the asset or liability being
and faithfully represented) information measured (F5.2)
Definition of asset + recognition criteria = Assets
Definition of liability + recognition criteria = Liability
An item that meets the definition of an asset or liability but not recognized but
disclosed in the notes is referred to as unrecognized asset or unrecognized Measurement of the Elements of Financial Statements
liability Measurement involves assigning monetary amounts at which the elements of the
The recognition of one element (or a change in its carrying amount) requires the financial statements are to be recognized and reported (F 4.54)
recognition or derecognition of another element. For example: recording a sale The FRSC Framework acknowledges that a variety of measurement bases are
increases both cash (asset) and sales (income), accruing salaries increases both used today to different degrees and in varying combinations in financial
salaries expense and salaries payable, and recording the earning of a previously statements, including (F 4.55) :
unearned income will decrease liability and increase income 1. Historical Cost – Assets are recorded at their original cost. Liabilities are
Recognition of income occurs simultaneously with the recognition of increases in recorded at their original amount received or the cash expected to be paid out
assets or decreases in liabilities to settle them. Historical cost is the measurement basis most commonly used
Recognition of expense occurs simultaneously with the recognition of increases in today, but it is usually combined with other measurement bases. (F4.56).
liabilities or decreases in assets 2. Current Value –
a. Fair value - Assets are recorded at the amount that they could be sold for
Non-Recognition now and similarly liabilities are recorded at the amount expected to be
Relevance – The recognition of an item may not provide relevant information if : paid out in an orderly transaction between market participants at the
a. It is uncertain whether an asset or liability exists or measurement date ( F6.12) Fair value is not adjusted for transaction cost.
b. An asset or liability exists, but the probability of an inflow or outflow of b. Value in use for assets and fulfilment value for liabilities –
economic benefits is low (F5.12) Value in use is the present value of the cash flows, or other economic
benefits, that an entity expects to derive from the use of an asset and
Faithful Representation from its ultimate disposal.
The level of measurement certainty and other factors affect an item’s faithful Fulfillment value is the present value of the cash, or other economic
representation. An exceptionally high measurement uncertainty can affect the faithful resources, that an entity expects to be obliged to transfer as it fulfils a
representation of an item, such as when the item can only be measured using cash liability.
flow-based measurement techniques. In addition, one or more of the following Present value means discounted, that is it involves discounting future
circumstances exists : cash flows to take account of the time value of money.
a. There is an exceptionally wide range of possible outcomes, and each outcome c. Current Cost – Assets are recorded at the amount that would have to be
is exceptionally difficult to estimate. paid out at the measurement date for an equivalent asset. Liabilities are
b. The measure is highly sensitive to small changes in estimates of ht probability recorded at the value that they could be settled for at the measurement
of different outcomes. date. The transactions costs that would be incurred at that date were
considered.
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Historical cost and current cost are entry values as they reflect prices in acquiring an c. Significant judgments made in the process of applying the entity’s
asset or incurring a liability. Fair value, value in use and fulfilment value are exit accounting policies
values, that is, they reflect prices in selling or using an asset or transferring / fulfilling 4. Supporting information or computation for line items presented in the FS
a liability. 5. Other financial and non-financial disclosures
The FRSC Framework does not include concepts or principles for selecting which
measurement basis should be used for elements of financial statements or
circumstances. Individual standards and interpretations do provide this guidance,
however.
Accounting Process
Derecognition is the opposite of recognition. It is the removal of previously THE ACCOUNTING CYCLE
recognized element from the entity’s financial statement. It occurs when the item no The accounting cycle represents the steps or procedures used in recording
longer meet the definition, whether asset or liability. For example, an entity loses transactions and preparing financial statements. The accounting cycle implements the
control when a previously recognized asset was sold. Control is part of the definition accounting process.
of the asset, therefore it will be derecognized since the item no longer meet its
definition. Steps in Accounting Cycle
1. Analyzing the business documents or transactions.
Purpose of Notes to Financial Statements 2. Journalizing
To present information about the basis of preparation of financial statements and 3. Posting
significant accounting policies used by the entity. 4. Preparing the unadjusted trial balance
To disclose information required by PFRS. 5. Preparing the adjusting entries
To provide additional information that helps clarify items presented in the 6. Preparing the financial statements
financial statements. 7. Preparing the closing entries
8. Preparing a post-closing trial balance
Presenting the Notes to Financial Statements 9. Preparing the reversing entries
Present the note in a systematic manner.
Cross-refer each item in the financial statements to any related information in the The accounting process can be classified into two parts, namely recording phase and
notes. summarizing phase. Steps 1 to 4 are within the recording phase while Steps 5 to 9 are
Present the notes in the following order: within the summarizing phase.
1. Company information
2. Statement of compliance with PFRS (Full PFRS, PFRS for SME’s or SEs) NOTE : The unadjusted and post-closing trial balance, reversing entries and
3. Summary of significant accounting policies worksheet are optional steps in the accounting cycle.
a. Measurement basis used in preparing the financial statements
b. Accounting policies that are relevant to an understanding of the financial Module 2
statements
Lecture Guide 2 : Statement of Financial Position
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Structure and Content of Financial Statements in General The entity does not have an unconditional right to defer settlement of the liability
Philippine Accounting Standards (PAS 1) requires an entity to clearly identify: (PAS for at least twelve months after reporting date
1.49-51) the financial statements, which must be distinguished from other
information in a published document each financial statement and the notes to the Classify all other liabilities as non-current when :
financial statements. In addition, the following information must be displayed When a long-term debt is expected to be refinanced under an existing loan facility,
prominently, and repeated as necessary: (PAS 1.51) and the entity has the discretion to do so, the debt is classified as non-current,
the name of the reporting entity and any change in the name even if the liability would otherwise be due within 12 months (PAS 1.73)
whether the financial statements are a group of entities or an individual entity If a liability has become payable on demand because an entity has breached an
information about the reporting period undertaking under a long-term loan agreement on or before reporting date, the
the presentation currency (as defined by PAS 21 The Effects of Changes in Foreign liability is current, even if the lender has agreed, after the reporting date and
Exchange Rates) before the authorization of the financial statement for issue, not to demand
the level of rounding used (e.g. thousands, millions). payment as a consequence of the breach (PAS 1.74)
The liability is classified as non-current if the lender agreed by the reporting date
Current / Non-Current Distinction to provide a period of grace ending in at least 12 months after the end of the
Present assets and liabilities separately under current and non-current reporting period, within which the entity can rectify the breach and during which
classification unless presentation based on liquidity is reliable and more relevant. the lender cannot demand immediate repayment.(PAS 1.75)
Assets and liabilities shall be presented in order of approximate liquidity Settlement by the issue of equity instruments does not impact classification (PAS
(ascending or descending) 1.76B)
Classify assets and liabilities as current if they are : Presentation of Items in the Statement of Financial Position
Involved in the operating cycle Present material items of different nature or function separately
Expected to be realized or settled within twelve months from the reporting date. PFRS does not prescribe sequence or format of presentation
Classes of equity
- Paid-in capital
- Share Premium
- Retained Earnings
- Income and expenses recognized in other comprehensive income
Format of Statement
PAS 1 does not prescribe the format of the statement of financial position. Assets can
be presented current then non-current, or vice versa and liabilities and equity can be
presented current then non-current then equity, or vice versa. A net asset
presentation (assets minus liabilities) is allowed. The long-term financing approach
used in UK and elsewhere – fixed assets +current assets-short term payables = long
term debt plus equity, is also acceptable.