Chapter 1
DEFINITION OF ACCOUNTING
The Accounting Standards Council provides the following definition:
Accounting is a service activity. The accounting function is to provide quantitative information,
primarily financial in nature, about economic entities, that is intended to be useful in making
economic decision.
The Committee on Accounting Terminology of the American Institute of Certified Public
Accountants provides the following definition:
Accounting is the art of recording, classifying and 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.
The American Accounting Association in its Statement of Basic Accounting Theory offers the
following definition:
Accounting is the process of identifying, measuring and communicating economic
information to permit informed judgment and decision by users of the information.
Important points
The following important points made in the definition of accounting should be noted:
One - Accounting is about quantitative information.
Two - The information is likely to be financial in nature.
Three The information should be useful in decision making.
The definition that has stood the test of time is the definition given by the American Accounting
Association. This definition states that the very purpose of accounting is to provide quantitative
information to be useful in making an economic decision.
The definition also states that accounting has a number of
components, namely:
a. Identifying as the analytical component.
b. Measuring as the technical component.
c. Communicating as the formal component.
Identifying
This accounting process is the recognition or nonrecognition of business activities as
"accountable" events.
Not all business activities are accountable. Cannot be quantified
For example, the hiring of employees, the death of the entity president and the entering into a
contract are all business activities but such events are not accountable because such activities
cannot be quantified expressed in terms of a unit of measure.
An event is accountable or quantifiable when it has an effect on assets, liabilities and equity.
In other words, the subject matter of accounting is economic activity or the measurement of
economic resources and economic obligations. Only economic activities are emphasized and
recognized in accounting.
Sociological and psychological matters are beyond the province of accounting.
External and internal transactions
Economic activities of an entity are referred to as transactions which may be classified as
external and internal.
External transactions or exchange transactions are those economic events involving one
entity and another entity.
Examples of external transactions are:
a. Purchase of goods from a supplier
b. Borrowing money from a bank
c. Sale of goods to a customer
d. Payment of salaries to employees
e. Payment of taxes to the government.
Internal transactions are the economic activities that take place entirely within the entity only. No
other parties are involved.
Production and casualty loss are examples of internal transactions. Production is the process by
which resources are transformed into products.
Casualty is any sudden and unanticipated loss from fire, flood, earthquake and other event
ordinarily termed as an act of God.
Measuring
Measuring is the accounting process of assigning of peso amounts to the accountable
economic transactions and events,
If accounting information is to be useful, it must be expressed in terms of a common financial
denominator.
Financial statements without monetary amounts would be largely unintelligible or
incomprehensible. The measurement bases are historical cost and current value
Historical cost is the original acquisition cost and the most common measure of financial
transactions.
Current value includes fair value, value in use, fulfillment value and current cost.
Communicating
Communicating is the process of preparing and distributing accounting reports to potential
users of accounting information.
Identifying and measuring are pointless if the information contained in the accounting records
cannot be communicated in some form to potential users.
Actually, the communicating process is the reason why accounting has been called the
"universal language of business".
Implicit in the communication process are the recording,
classifying and summarizing aspects of accounting. Recording or journalizing is the process of
systematically maintaining a record of all economic business transactions
after they have been identified and measured.
Classifying is the sorting or grouping of similar and interrelated economic transactions into their
respective classes.
Classifying is accomplished by posting to the ledger.
The ledger is a group of accounts which are systematically categorized into asset accounts,
liability accounts, equity accounts, revenue accounts and expense accounts.
Summarizing is the preparation of financial statements which include the statement of financial
position, income statement, statement of comprehensive income, statement of changes in
equity and statement of cash flows.
Overall objective of accounting
The overall objective of accounting is to provide quantitative financial information about a
business useful to statement users particularly owners and creditors in making economic
decisions.
Accounting is an information system that measures business activities, processes information
into financial reports and communicates the reports to decision makers.
An accountant's primary task is to supply financial information so that the statement users could
make informed judgment and better decision.
Financial reports tell us how well an entity is performing in terms of profit and loss and where it
stands in financial terms.
THE ACCOUNTANCY PROFESSION
At present, Republic Act No. 9298 is the law regulating the practice of accountancy in the
Philippines.
This law is known as the Philippine Accountancy Act of 2004. Accountancy has developed as a
profession attaining a status equivalent to that of law and medicine..
In the Philippines, in order to qualify to practice the accountancy profession, a person must
finish a degree in Bachelor of Science in Accountancy and pass a very difficult government
examination given by the Board of Accountancy..
The Board of Accountancy is the body authorized by law to promulgate rules and regulations
affecting the practice of the accountancy profession in the Philippines.
The Board of Accountancy is responsible for preparing and grading the Philippine CPA
examination.
This computer-based examination is offered twice a year, one in May and another one in
October, in authorized testing centers around the country.
Limitation of the practice of public accountancy
Single practitioners and partnerships for the practice of public accountancy shall be registered
certified public accountants in the Philippines.
A certificate of accreditation shall be issued to certified public accountants in public practice only
upon showing in accordance with rules and regulations promulgated by the Board of
Accountancy and approved by the Professional Regulation Commission that such registrant has
acquired a minimum of three years of meaningful experience in any of the areas of public
practice including taxation.
The Securities and Exchange Commission shall not register any corporation organized for the
practice of public accountancy.
Accreditation to practice public accountancy
Certified public accountants, firms and partnerships of certified public accountants, including
partners and staff members are required to register with the Board of Accountancy and
Professional Regulation Commission for the practice of public accountancy.
The Professional Regulation Commission upon favorable recommendation of the Board of
Accountancy shall issue the Certificate of Registration to practice public accountancy which
shall be valid for 3 years and renewable every 3 years upon payment of required fees.
Certified Public Accountants generally practice their profession in three main areas, namely:
a. Public accounting
b. Private accounting
c. Government accounting.
PUBLIC ACCOUNTING
The field of public accounting or public accountancy is composed of individual practitioners,
small accounting firms and large multinational organizations that render independent and expert
financial services to the public.
Public accountants usually offer three kinds of services, namely auditing, taxation and
management advisory services. As a matter of fact, large multinational accounting firms have
separate division for each of these services.
Auditing
Auditing has traditionally been the primary service offered by most public accounting
practitioners.
Auditing or external auditing is the examination of financial statements by independent certified
public accountant for the purpose of expressing an opinion as to the fairness with which the
financial statements are prepared.
Actually, external auditing is the attest function of independent CPAs.
The Bureau of Internal Revenue requires audited financial statements to accompany the filing of
annual income tax return.
Banks and other lending institutions frequently require an audit by an independent CPA before
granting a loan to the borrower.
Creditors and prospective investors place considerable reliance on audited financial statements
on making economic decision.
Taxation
Taxation service includes the preparation of annual income tax returns and determination of tax
consequences of certain proposed business endeavors.
The CPA not infrequently represents the client in tax investigations.
To offer this service effectively and efficiently, the public accountant must be thoroughly familiar
with the tax laws and regulations and updated with changes in taxation law and court cases
concerned with interpreting taxation law.
Management advisory services
Management advisory services have become increasingly important in recent years although
audit and tax services are undoubtedly the mainstay of public accountants.
The term management advisory services has no precise coverage but is used generally to refer
to services to clients on the following matters:
a. Advice on installation of computer system
b. Quality control
c. Installation and modification of accounting system
d. Budgeting
e. Forward planning and forecasting
PRIVATE ACCOUNTING
Many Certified Public Accountants are employed in business entities in various capacity as
accounting staff, chief accountant, internal auditor and controller.
The highest accounting officer in an entity is known as the controller.
The major objective of the private accountant is to assist management in planning and
controlling the entity's operations.
Private accounting includes maintaining the records, producing the financial reports, preparing
the budgets and controlling and allocating the resources of the entity.
GOVERNMENT ACCOUNTING
Government accounting encompasses the process of analyzing, classifying, summarizing and
communicating all transactions involving the receipt and disposition of government funds and
property and interpreting the results thereof.
The focus of government accounting is the custody and administration of public funds.
Many Certified Public Accountants are employed in some branches of the government, more
particularly Bureau of Internal Revenue, Commission on Audit, Securities and Exchange
Commission and Bangko Sentral ng Pilipinas.
CONTINUING PROFESSIONAL DEVELOPMENT (CPD)
Republic Act No. 10912 is the law mandating and strengthening the continuing professional
development program for all regulated professions, including the accountancy profession.
All certified public accountants shall abide by the requirements, rules and regulations on
continuing professional development to be promulgated by the Board of Accountancy, subject to
the approval of the Professional Regulation Commission. e due cone)
Continuing professional development is the acquisition of advance knowledge, skill and
proficiency.
Continuing professional development raises and enhances the technical skill and competence
of the Certified Public Accountant.
CPD credit units
The CPD credit units refer to the CPD credit hours required for the renewal of CPA license and
accreditation of a CPA to practice the accountancy profession every three years.
Under the new BOA Resolution, all Certified Public Accountants regardless of area or sector of
practice shall be required to comply with 120 CPD credit units.
The Continuing Professional Development is required for the renewal of CPA license and
accreditation of CPA to practice the accountancy profession.
The Continuing Professional Development has become mandatory for Certified Public
Accountants.
As recently promulgated, only 15 CPD credit units are required for the renewal of CPA license.
However, 120 CPD credit units are required for accreditation of a CPA to practice the
accountancy profession.
Excess credit units earned shall not be carried over to the next three-year period, except credit
units earned for masteral and doctoral degrees.
Exemption from CPD
A CPA shall be permanently exempted from CPD requirements upon reaching the age of 65
years.
However, this exemption applied only to the renewal of CPA license and not for the purpose of
accreditation to practice the accountancy profession.
Accounting versus auditing
In a broad sense, accounting embraces auditing. Auditing is one of the areas of accounting
specialization.
In a limited sense, accounting is essentially constructive in nature. Accounting ceases when
financial statements are already prepared.
On the other hand, auditing is analytical. The work of an auditor begins when the work of the
accountant ends.
After the financial statements are prepared, the auditor will begin to perform the task of auditing.
The auditor examines the financial statements to ascertain whether they are in conformity with
generally accepted accounting principles..
Accounting versus bookkeeping
Bookkeeping is procedural and largely concerned withi development and maintenance of
accounting records.
Bookkeeping is the "how" of accounting.
Accounting is conceptual and is concerned with the why, reason or justification for any action
adopted.
Bookkeeping is a procedural element of accounting as arithmetic is a procedural element of
mathematics.
Accounting versus accountancy
Broadly speaking, the two terms are synonymous because they both refer to the entire field of
accounting theory and practice.
Technically speaking, however accountancy refers to theprofession of accounting practice.
Accounting is used in reference only to a particular field of accountancy such as public
accounting, private accounting and government accounting.
Financial accounting versus managerial accounting
Financial accounting is primarily concerned with the recording of business transactions and the
eventual preparation of financial statements.
Financial accounting focuses on general purpose reports known as financial statements
intended for internal and external users.
Financial accounting is the area of accounting that emphasizes reporting to creditors and
investors.
Managerial accounting is the accumulation and preparation of financial reports for internal users
only.
In other words, managerial accounting is the area of accounting that emphasizes developing
accounting. information for use within an entity.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES
Accounting has evolved through time changing with the needs of society. As new types of
transactions occur in trade and commerce, accountants develop rules and procedures for
recording them.
These accounting rules, procedures and practices came to be known as generally accepted
accounting principles or simply GAAP.
The principles have developed on the basis of experience, reason, custom, usage and practical
necessity.
Generally accepted accounting principles represent the rules, procedures, practice and
standards followed in the preparation and presentation of financial statements.
Generally accepted accounting principles are like laws that must be followed in financial
reporting.
The process of establishing GAAP is a political process which incorporates political actions of
various interested user groups as well as professional judgment, logic and research.
Purpose of accounting standards
The overall purpose of accounting standards is to identify proper accounting practices for the
preparation and presentation of financial statements.
Accounting standards create a common understanding between preparers and users of
financial statements particularly the measurement of assets and liabilities.
A set of high-quality accounting standards is a necessity to ensure comparability and uniformity
in financial statements based on the same financial information.
FINANCIAL REPORTING STANDARDS COUNCIL
In the Philippines, the development of generally accepted accounting principles is formalized
initially through the creation of the Accounting Standards. Council or ASC.
The Financial Reporting Standards Council or FRSC now replaces the Accounting Standards
Council.
The FRSC is the accounting standard setting body created by the Professional Regulation
Commission upon recommendation of the Board of Accountancy to assist the Board of
Accountancy in carrying out its powers and functions provided under R.A. Act No. 9298.
The main function is to establish and improve accounting standards that will be generally
accepted in the Philippines.
The accounting standards promulgated by the Financial Reporting Standards Council constitute
the highest hierarchy of generally accepted accounting principles in the Philippines.
The approved statements of the FRSC are known as Philippine Accounting Standards or
PAS and Philippine Financial Reporting Standards or PFRS.
Composition of FRSC
The FRSC is composed of 15 members with a Chairman who had been or is presently a senior
accounting practitioner and 14 representatives from the following:
Board of Accountancy
Securities and Exchange Commission
Bangko Sentral ng Pilipinas
Bureau of Internal Revenue
Commission on Audit
Major organization of preparers and
users of financial statements-Financial Executives Institute
of the Philippines or FINEX
Accredited national professional organization of CPAs:
Public Practice
Commerce and Industry
Academe or Education
Government
1
1
1
1
1
Total
14
1
2
2
2
2
The Chairman and members of the FRSC shall have a term of 3 years renewable for another
term.
Philippine Interpretations Committee
The Philippine Interpretations Committee or PIC was formed by the FRSC in August 2006 and
has replaced the Interpretations Committee or IC formed by the Accounting Standards Council
in May 2000.
The role of the PIC is to prepare interpretations of PFRS for approval by the FRSC and to
provide timely guidance on financial reporting issues not specifically addressed in current
PFRS.
In other words, interpretations are intended to give authoritative guidance on issues that are
likely to receive divergent or unacceptable treatment because the standards do not provide
specific and clearcut rules and guidelines.
The counterpart of the PIC in the International Accounting Standards Board is the International
Financial Reporting Interpretations Committee or IFRIC.
INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE
The International Accounting Standards Committee or IASC is an independent private sector
body, with the objective of achieving uniformity in the accounting principles which are used by
business and other organizations for financial reporting around the world.
It was formed in June 1973 through an agreement made by professional accountancy bodies
from Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom
and Ireland, and the United States of America. The IASC is headquartered in London, United
Kingdom.
Objectives of IASC
a. To formulate and publish in the public interest accounting standards to be observed in the
presentation of financial statements and to promote their worldwide acceptance and
observance.
b. To work generally for the improvement and harmonization of regulations, accounting
standards and procedures relating to the presentation of financial statements.
INTERNATIONAL ACCOUNTING STANDARDS BOARD
The International Accounting Standards Board or IASB now replaces the International
Accounting Standards Committee or IASC.
The IASB publishes standards in a series of pronouncements called International Financial
Reporting Standards or IFRS.
However, the IASB has adopted the body of standards issued by the IASC. The
pronouncements of the IASC continue to be designated as International Accounting Standards
or IAS.
The IASB standard-setting process includes in the correct order research, discussion paper,
exposure draft and accounting standard.
The IASB declared that the merits of proposed standards are assessed from a position of
neutrality.
A due process system is employed to enable interested parties to express their views on issues
under consideration.
Move toward IFRS
In developing accounting standards that will be generally accepted in the Philippines, standards
issued by other standard setting bodies such as the USA Financial Accounting Standards Board
(FASB) and the IASB are considered.
In the past years, most of the Philippine standards are based on American accounting
standards.
At present, the FRSC has adopted in their entirety all International Accounting Standards and
International Financial Reporting Standards.
The move toward IFRS is essential to achieve the goal of one uniform and globally accepted
financial reporting standards.
Philippine Financial Reporting Standards
The Financial Reporting Standards Council issues standards in a series of pronouncements
called Philippine Financial Reporting Standards or PFRS.
The Philippine Financial Reporting Standards collectively include all of the following:
a. Philippine Financial Reporting Standards which correspond to International Financial
Reporting Standards.
The Philippine Financial Reporting Standards are numbered the same as their
counterpart in International Financial Reporting Standards.
B. Philippine Accounting Standards which correspond to International Accounting
Standards.
The Philippine Accounting Standards are numbered the same as their counterpart in
International Accounting Standards.
c. Philippine Interpretations which correspond to Interpretations of the IFRIC and Interpretations
developed by the Philippine Interpretations Committee.
Accounting is a service activity and the function is to provide quantitative information,
primarily financial in nature about economic entities, that is intended to be useful in
making decision. This accounting definition is given by
a. Accounting Standards Council
b. AICPA Committee on Accounting Terminology
c. American Accounting Association
d. Professional Regulatory Board of Accountancy
All of the following describe accounting, except
a. A service activity
b. An information system
c. A universal language of business
d. An exact science rather an art
The important points made in the definition of accounting include all of the following,
except
a. Accounting information is quantitative
b. Accounting information is both quantitative and qualitative
c. Accounting information is financial in nature
d. Accounting information is useful in decision making
This accounting process is the recognition or nonrecognition of business activities as
accountable events
a. Identifying
b. Measuring
c. Communicating
d. Reporting
What are the events that affect the entity and in which other entities participate?
a. Internal events
b. External events
c. Current events
d. Obligating events
Which is incorrect in relation to an accountable event?
a. An event is accountable when it has an effect on asset, liability or equity
b. The subject matter of accounting is the measurement of economic resources
and obligations
c. Only economic activities are emphasized and recognized in accounting.
d. Sociological and psychological matters are quantifiable.
What is the measuring component in the definition of accounting?
a. The recognition or nonrecognition of business activities as accountable events.
b. The assigning of peso amounts to the accountable events.
c. The preparation and distribution of accounting reports to users of accounting
information.
d. The preparation of audit report by CPAs
The most common financial attribute used in measuring financial information is
a. Historical cost
b. Current cost
c. Fair value
d. Value in use
The communicating process of accounting includes all of the following, except
a. Recording
b. Classifying
c. Summarizing
d. Interpreting
The overall objective of financial reporting is to provide information
a. That is useful for decision making
b. About assets, liabilities and equity of an entity
c. About financial performance during a period
d. That allows owners to assess management performance
What is the law regulating the practice of accountancy in the Philippines?
a. R.A. No. 9298
b. R.A. No. 9198
c. R.A. No. 9928
d. R.A. No. 9892
What is the body authorized by law to promulgate rules and regulations affecting the
practice of the accountancy profession in the Philippines?
a. Board of Accountancy
b. Philippine Institute of Certified Public Accountants
c. Securities and Exchange Commission
d. Financial Reporting Standards Council
What are the four main areas in the practice of the accountancy profession?
a. Public accounting, private accounting and managerial accounting
b. Auditing, taxation and managerial accounting
c. Financial accounting, managerial accounting and corporate accounting
d. Public accounting, private accounting, government accounting and education
Which statement is incorrect in relation to the practice of public accountancy?
a. Single practitioners for the practice of public accountancy shall be registered
CPAs in the Philippines
b. Partners of partnerships formed for the practice of public accountancy shall be
registered CPAs in the Philippines
c. The Securities and Exchange Commission can register any corporation
organized for the practice of public accountancy
d. All of the other statements are incorrect
CPAs are licensed by
a. Philippine Institute of Certified Public Accountants
b. Securities and Exchange Commission
c. City Government
d. State Government
What is the standard-setting body in the Philippines at the present time?
a. Accounting Standards Council
b. Auditing and Assurance Standards Council
c. Philippine Accounting Standards Board
d. Financial Reporting Standards Council
All of the following are represented in FRSC, except
a. Board of Accountancy
b. Securities and Exchange Commission
c. Commission on Audit
d. Department of Budget and Management
The Philippine Financial Reporting Standards collectively include
a. PFRS corresponding to IFRS
b. PAS corresponding to IAS
c. Philippine Interpretations corresponding to IFRIC and SIC Interpretations and
Interpretations by PIC
d. All of the other choices are included in the Philippine Financial Reporting
Standards
Accounting standard-setting has been characterized as
a. A political process
b. Using the scientific method
c. Pure deductive reasoning
d. A legal process
GAAP is an abbreviation for
a. Generally authorized accounting procedures
b. Generally applied accounting procedures
c. Generally accepted auditing procedures
d. Generally accepted accounting principle
What is the primary service of CPAs in public practice?
a. Auditing
b. Taxation
c. Managerial accounting
d. Controllership
Accountants employed in entities in various capacity as accounting staff, chief
accountant or controller are said to be engaged in
a. Public accounting
b. Private accounting
c. Government accounting
d. Financial accounting
It is the area of the accountancy profession that encompasses the process of analyzing,
classifying, summarizing and communicating all transactions involving the receipt and
disposition of government funds and property and interpreting the results thereof.
a. Internal auditing
b. External auditing
c. Private accounting
d. Government accounting
How many CPD credit units are required for accreditation to practice the accountancy
profession?
a. 120 units
b. 100 units
c. 60 units
d. 15 units
A non-working CPA shall be permanently exempted from renewal of CPA license
a. At the age of 65 years
b. When working abroad
c. When practicing the profession abroad
d. When studying abroad
The International Accounting Standards Board was formed
a. To enforce IFRS in foreign countries
b. To develop a single set of high quality IFRS
c. To establish accounting standards for multinational entities
d. To develop accounting standards for countries that do not have their own
standard-setting bodies
The International Accounting Standards Board
a. Was the predecessor to the IASC
b. Can overrule the USA GAAP when their policies disagree
c. Promotes the use of high-quality and understandable global accounting
standards
d. Has its headquarters in Geneva
The IASB declared that the merits of proposed standards are assessed
a. From the position of neutrality
b. From the position of materiality
c. Based on possible impact on behavior
d. Based on arguments of lobbyist
The standard-setting process includes in the correct order
a. Exposure draft, research, discussion paper, and accounting standard
b. Research, exposure draft, discussion paper and accounting standard
c. Research, discussion paper, exposure draft and accounting standard
d. Discussion paper, research, exposure draft and accounting standard
The IASB employs a due process system which
a. Is an efficient system for collecting dues from members
b. Enables interested parties to express their views on issues under
consideration
c. Identifies the accounting issues that are the most important
d. Requires that all CPAs must receive a copy of IFRS
What is due process in standard-setting by IASB?
a. IASB operaties in full view of the public
b. Public hearings are held on proposed standards
c. Interested parties can make their views known
d. All of the choices are part of due process in standard-setting
The standards published by IASB are called
a. International Accounting Standards
b. Financial Reporting Standards
c. International Financial Reporting Standards
d. Statement of Financial Accounting Standards
What is a possible danger if politics plays too big a role in developing IFRS?
a. Financial reporting standards are not truly generally accepted
b. Individuals may influence the standards
c. User groups become active
d. The IASB delegates its authority to elected officials
Accounting standard-setting
a. Can be described as a political process which reflects political actions of
various interested user groups as well as a product of research and logic
b. Is based solely on research and empirical findings
c. Is a legalistic process
d. Is democratic that in the sense that a majority of accountants must agree with
a standard before it becomes enforceable
IFRIC Interpretations issued by IASB
a. Are considered authoritative and must be followed
b. Cover newly identified financial reporting issues not specifically addressed
c. Cover issues where unsatisfactory or conflicting interpretations have
developed
d. All of the other statements are true about IFRIC Interpretations
Financial accounting is concerned with
a. General purpose reports on financial position and financial performance
b. Special reports for inventory management
c. Special reports for income tax computation
d. General purpose reports on changes in share prices
Financial accounting can be broadly defined as the area of accounting that prepares
a. General purpose financial statements to be used by parties internal to the
entity
b. Financial statements to be used by investors
c. General purpose financial statements to be used by parties both internal and
external to the entity
d. Financial statements to be used primarily by management
Financial accounting emphasizes reporting to
a. Management
b. Regulatory bodies
c. Internal auditors
d. Creditors and investors
Management accounting emphasizes
a. Reporting financial information to external users
b. Reporting to the SEC
c. Expertise in data processing
d. Developing accounting information for use within an entity
Which statement is true regarding managerial and financial accounting?
a. Managerial accounting is generally more precise
b. Managerial accounting need not follow generally accepted accounting
principles while financial accounting must follow GAAP
c. Managerial accounting has a future focus
d. The emphasis on managerial accounting is relevance and the emphasis on
financial accounting is timeliness
Generally accepted accounting principles
a. Are accounting adaptations based on law
b. Derive their credibility and authority from legal rulings and court precedents
c. Derive their credibility and authority from a government regulatory authority
d. Derive their credibility and authority from general recognition and acceptance
by the accountancy profession
Which statement best describes GAAP?
a. The accounting principles have been formulated in the public sector
b. The accounting principles have been developed on the basis of such factors
as usage and practical necessity
c. The accounting principles are the same as laws
d. The accounting principles do not apply to small and medium-sized entities
Proper application of accounting principles is most dependent upon
a. Existence of specific guidelines
b. Oversight of regulatory bodies
c. External audit function
d. Professional judgment of the accountant
Once an accounting standard has been established
a. The standard is continually reviewed to see if modification is necessary.
b. The standard is not reviewed unless a regulatory authority makes a complaint
c. The task of reviewing the standard is given to the national accounting
organization
d. The principle of consistency requires that no revisions ever be made to the
standard
The primary responsibility for properly applying GAAP lies with
a. External auditor
b. Internal auditor
c. Management
d. National accounting organzation
Chapter 2
CONCEPTUAL FRAMEWORK
The Conceptual Framework for Financial Reporting is a complete, comprehensive and
single document promulgated by the International Accounting Standards Board.
The Conceptual Framework is a summary of the terms and concepts that underlie the
preparation and presentation of financial statements for external users.
In other words, the Conceptual Framework describes the concepts for general purpose
financial reporting.
The Conceptual Framework is an attempt to provide an overall theoretical foundation for
accounting.
The Conceptual Framework is intended to guide standard setters, preparers and users
of financial information in the preparation and presentation of statements.
The Conceptual Frmework is the underlying theory for the development of accounting
standards and revision of previously issued accounting standards.
The Conceptual Framework will be used in future standard setting decision but no
changes are made to the current IFRS.
The Conceptual Framework provides the foundation for Standards that:
a. Contribute to transparency by enhancing international comparability and
quality of financial information.
b. Strengthen accountability by reducing information gap between the providers
of capital and the people to whom they have entrusted their money.
c. Contribute to economic efficiency by helping investors to identify opportunities
and risks across the world.
Purposes of Revised Conceptual Framework
a. To assist the International Accounting Standards Board to develop IFRS
Standards based on consistent concepts.
b. To assist preparers of financial statements to develop consistent accounting
policy when no Standard applies to a particular transaction or other event or
where an issue is not yet addressed by an IFRS.
c. To assist preparers of financial statements to develop accounting policy when
a Standard allows a choice of an accounting policy.
d. To assist all parties to understand and interpret the IFRS Standards.
Authoritative status of Conceptual Framework
If there is a standard or an interpretation that specifically applies to a transaction,
the standard or interpretation overrides the Conceptual Framework,
In the absence of a standard or an interpretation that specifically applies to a
transaction, management shall consider the applicability of the Conceptual
Framework in developing and applying an accounting policy that results in
information that is relevant and reliable.
However, it is to be stated that the Conceptual Framework is not an International
Financial Reporting Standard.
Nothing in the Conceptual Framework overrides any specific International
Financial Reporting Standard.
In case where there is a conflict, the requirements of the International Financial
Reporting Standards shall prevail over the Conceptual Framework.
Users of financial information
Under the Conceptual Framework for Financial Reporting, the users of financial
information may be classified into two, namely:
a. Primary users
b. Other users
The primary users include the existing and potential investors, lenders and other
creditors.
The other users include the employees, customers, governments and their agencies,
and the public.
Primary users
The primary users of financial information are the parties to whom general
purpose financial reports are primarily directed.
Such primary users cannot require reporting entities to provide information
directly to them and therefore must rely on general purpose financial reports for
how much of the financial information is needed.
Existing and potential investors
Existing and potential investors are concerned with the risk inherent in and return
provided by their investments.
The investors need information to help them determine whether they should buy,
hoid or sell.
Shareholders are also interested in information which enables them to assess
the ability of the entity to pay dividends.
Lenders and other creditors
Existing and potential lenders and other creditors are interested in information
which enables them to determine whether their loans, interest thereon and other
amounts owing to them will be paid when due.
Other users
By residual definition, other users are users of financial information other than the
existing and potential investors, lenders and other creditors.
Other users are so called because they are parties that may find the general
purpose financial reports useful but the reports are not directed to them primarily.
Employees
Employees are interested in information about the stability and profitability of the
entity.
The employees are interested in information which enables them to assess the
ability of the entity to provide remuneration, retirement benefits and employment
opportunities.
Customers
Customers have an interest in information about the continuance of an entity
especially when they have a long-term involvement with or are dependent on the
entity.
Governments and their agencies
Governments and their agencies are interested in the allocation of resources and
therefore the activities of the entity.
These users require information to regulate the activities of the entity, determine
taxation policies and as a basis for national income and similar statistics.
Public
Entities affect members of the public in a variety of ways.
For example, entities make substantial contribution to the local economy in many
ways including the number of people they employ and their patronage of local
suppliers.
Financial statements may assist the public by providing information about the
trend and the range of its activities.
Scope of Revised Conceptual Framework
1. Objective of financial reporting
2. Qualitative characteristics of useful financial information
3. Financial statements and reporting entity
4. Elements of financial statements
5. Recognition and derecognition
6. Measurement
7. Presentation and disclosure
8. Concepts of capital and capital maintenance
OBJECTIVE OF FINANCIAL REPORTING
The objective of financial reporting forms the foundation of the Conceptual
Framework.
The overall objective of 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.
The objective of financial reporting is the "why", purpose or goal of accounting.
Financial reporting is the provision of financial information about an entity to
external users that is useful to them in making economic decisions and for
assessing the effectiveness of the entity's management.
The principal way of providing financial information to external users is through
the annual financial statements.
However, financial reporting encompasses not only financial statements but also
other information such as financial highlights, summary of important financial
figures, analysis of financial statements and significant ratios.
Financial reports also include nonfinancial information such as description of
major products and a listing of corporate officers and directors.
Target users
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 such as employees, customers,
governments and their agencies.
The management of a reporting entity is also interested in financial information
about the entity.
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
The overall objective of financial reporting is to provide information useful for decision
making.
The Conceptual Framework places more emphasis on the importance of providing
information needed to assess the management stewardship of the entity's economic
resources.
Accordingly, the specific objectives of financial reporting are:
a. To provide information useful in making decisions about providing resources to
the entity.
b. To provide information useful in assessing the cash flow prospects of the
entity.
c. To provide information about entity resources, claims and changes in
resources and claims.
Economic decisions
Existing and potential investors need general purpose financial reports in order to
enable them in making decisions whether to buy, sell or hold equity investments.
Existing and potential lenders and other creditors need general purpose financial
reports in order to enable them in making decisions whether to provide or settle
loans and other forms of credit.
Assessing cash flow prospects
Decisions by existing and potential investors about buying. selling or holding
equity instruments depend on the returns that they expect from an investment,
for example, dividends.
Similarly, decisions by existing and potential lenders and other creditors about
providing or settling loans and other forms of credit depend on the principal and
interest payments or other returns that they expect.
Consequently, financial reporting should provide information useful in assessing
the amount, timing and uncertainty of prospects for future net cash inflows to the
entity.
Economic resources and claims
General purpose financial reports provide information about the financial position
of a reporting entity.
Financial position is information about the entity's economic resources and the
claims against the reporting entity.
The economic resources are the assets and the claims are the liabilities and
equity of the entity.
In other words, the financial position comprises the assets, liabilities and equity of
an entity at a particular moment in time.
Information about the nature and amounts of an entity's economic resources and
claims can help users identify the entity's financial strength and weakness.
Otherwise stated, information about financial position can help users to assess
the entity's liquidity, solvency and the need for additional financing.
Liquidity is the availability of cash in the near future to cover currently maturing
obligations.
Solvency is the availability of cash over a long term to meet financial
commitments when they fall due.
Information about priorities and payment requirements of existing claims can help
users to predict how future cash flows will be distributed among those with a
claim against the reporting entity.
Changes in economic resources and claims
General purpose financial reports also provide information about the effects of
transactions and other events that change the economic resources and claims.
Changes in economic resources and claims result from financial performance
and from other events or transactions, such as issuing debt or equity
instruments.
The financial performance of an entity comprises revenue, expenses and net
income or loss for a period of time.
In other words, financial performance is the level of income earned by the entity
through the efficient and effective use of its resources.
The financial performance of an entity is also known as results of operations and
is portrayed in the income statement and statement of comprehensive income.
Usefulness of financial performance
Information about financial performance helps users to understand the return that
the entity has produced on the economic resources.
Information about the return the entity has produced provides an indication of
how well management has discharged its responsibilities to make efficient and
effective use of the entity's economic resources.
Information about past financial performance is usually helpful in predicting the
future returns on the entity's economic resources.
Information about financial performance during a period is useful is assessing the
entity's ability to generate future cash inflows from operations.
Accrual accounting
The financial performance of the entity must be measured using the accrul basis
of accounting.
Accrual accounting depicts the effects of transactions and other events and
circumstances on an entity's economic resources and claims in the periods in
which those effects occur even if the resulting cash receipts and payments occur
in a different period.
In other words, under the accrual basis, the effects of transactions and other
events are recognized when they occur and not as cash is received or paid.
Simply stated, accrual accounting means that income is recognized when earned
regardless of when received and expense is recognized when incurred
regardless of when paid.
Information about financial performance measured in accordance with accrual
accounting provides a better basis for assessing past and future performance
than information solely about cash receipts and payments during a period.
Limitations of financial reporting
a. General purpose financial reports do not and cannot provide all of the
information that existing and potential investors, lenders and other creditors
need..
Primary users need to consider pertinent information from other sources, for
example, general economic conditions, political events and industry outlook.
b. General purpose financial reports are not designed to show the value of an
entity but the reports provide information to help the primary users estimate the
value of the entity.
c. General purpose financial reports are intended to provide common information
to users and cannot accommodate every request for information.
d. To a large extent, general purpose financial reports are based on estimate and
judgment rather than exact depiction.
Management stewardship
Information about how efficiently and effectively management has discharged its
responsibility to use the entity's economic resources helps users to assess
management stewardship of those resources.
Such information is also useful for predicting how management will use the
entity's economic resources in future periods.
Hence, the information can be useful for assessing the entity's prospects for
future net cash flows.
For example, management can decide not to dispose or sell investments when
prices are declining in order to avoid realized losses.
Which statement is true about the Conceptual Framework for Financial Reporting?
a. The Conceptual Framework is not a standard
b. The Conceptual Framework describes a concept for general purpose financial
reporting
c. In case of conflict, the requirements of the IFRS prevail over the Conceptual
Framework
d. All of these statements are true about the Conceptual Framework
Which is not a purpose of the Revised Conceptual Framework?
a. To assist the IASB to develop IFRS based on consistent concepts
b. To assist preparers to develop consistent accounting policy when no Standard
applies to a particular transaction or when Standard allows a choice of
accounting policy c. To assist all parties to understand and interpret the
Standards
d. To assist regulatory agencies in issuing rules and regulations for a particular
industry
The scope of the Revised Conceptual Framework comprises how many chapters?
a. Five
b. Six
c. Seven
d. Eight
The Conceptual Framework provides the foundation for Standards that
a. Contribute to transparency by enhancing international comparability and
quality of
financial information
b. Strengthen accountability of management
c. Contribute to economic efficiency by helping investors to identify opportunities
and risk
d. All of these are the result of Standards developed based on consistent
concepts
What is the authoritative status of the Conceptual Framework?
a. The Conceptual Framework has the highest level of authority
b. In absence of a standard or an interpretation that specifically applies to a
transaction,
the Conceptual Framework shall be followed
c. In the absence of a standard or an interpretation that specifically applies to a
transaction, management shall consider the applicability of the Conceptual
Framework in developing and applying an accounting policy that results in
information that is relevant and faithfully represented
d. The Conceptual Framework applies only when the IASB develops new
standards
The Conceptual Framework is intended to establish
a. GAAP in financial reporting b. The meaning of "present fairly in accordance
with
GAAP"
c. The objectives and concepts for use in developing standards of financial
accounting and reporting
d. The hierarchy of sources of GAAP
A Conceptual Framework should
a. Lead to uniformity of financial statements
b. Eliminate alternative accounting principles
c. Guide multinational entities in developing generally accepted auditing
standards
d. Define the basic objectives, terms and concepts of accounting
Which is not a purpose of the Conceptual Framework?
a. To provide definitions of key terms and fundamental concepts
b. To provide specific guidelines for resolving situations not covered by existing
accounting standards
c. To assist accountants in selecting among alternative accounting and reporting
methods
d. To assist the International Accounting Standards Board in the standard-setting
process
In the Conceptual Framework for Financial Reporting what provides the "why" of
accounting?
a. Measurement and recognition concept
b. Qualitative characteristic of accounting formation
c. Element of financial statement
d. Objective of financial reporting
The underlying theme of the Conceptual Framework is
a. Decision usefulness
b. Understability
c. Timeliness
d. Comparability
The objective of financial reporting
a. Is the foundation for the Conceptual Framework
b. Includes the qualitative characteristics of useful information
c. Is not found in the Conceptual Framework
d. All of these are correct choices regarding the objective of financial reporting
Which of the following is not a benefit associated with the Conceptual Framework?
a. A Conceptual Framework should increase users' understanding and
confidence in financial reporting
b. Practical problems should be more quickly solvable
c. A coherent set of accounting standards should result
d. Business entities will need for less assistance from accountants
Which statement is not true concerning the Conceptual Framework?
a. The Conceptual Framework should be a basis for standard setting
b. The Conceptual Framework should allow practical problems to be solved more
quickly
c. The Conceptual Framework should be based on fundamental truth derived
from the law of nature
d. The Conceptual Framework should increase user's understanding and
confidence in financial reporting
Users of financial reports include which of the following?
a. Creditors
b. Creditors and government agencies
c. Creditors and unions
d. Creditors, government agencies and unions
The primary users of financial information include
a. Existing and potential investors
b. Existing and potential lenders and other creditors
c. User group such as employees, customers, governments and their agencies,
and the public
d. Existing and potential investors, lenders and other creditors
Which group is not among the external users for whom financial statements are
prepared?
a. Customers
b. Suppliers
c. Employees
d. All of these are external users of financial statements
Which of the following is an internal user of financial information?
a. Board of Directors
b. Shareholder
c. Holder of bonds
d. Creditor with long-term contract
These users require information on risk and return provided by their investment
a. Investors
b. Employees
c. Lenders
d. Customers
These users are interested in formation about the profitability and stability of the entity in
order to assess the ability of entity to provide remuneration, retirement benefits and
employment opportunities
a. Customers
b. Public
c. Governments and their agencies
d. Employees
These users are interested in information that enables them to assess whether their
loans, the related interest thereon, and other amounts owing to them will be paid when
due
a. Lenders and other creditors
b. Borrowers
c. Trade creditors
d. Owners
These users are interested in information about the continuance of an entity, especially
when they have a long-term involvement with or are dependent on the entity
a. Customers
b. Employees
c. Trade unions
d. Suppliers
These users are interested in information in order to regulate the activities of an entity,
determine taxation policies and provide a basis for national statistics
a. Governments and their agencies
b. Major organization of users
c. Bureau of Internal Revenue
d. Department of Finance
These users need information on trends and recent developments where an entity
makes a substantial contribution to the local economy providing employment and using
local suppliers
a. The public
b. Goverments and their agencies
c. Finance entities
d. Private entities
The overall objective of financial reporting is to provide information
a. That is useful for decision making
b. About assets, liabilities and equity of an entity
c. About financial performance during a period
d. That allows owners to assess management performance
The primary focus of financial reporting has been on meeting the needs of which of the
following groups?
a. Management
b. Existing and potential investors, lenders and other creditors
c. National taxing authorities
d. Independent CPAs
The primary objective of financial reporting is to provide useful information to
a. Management
b. Capital providers
c. Regulatory body
d. Government
Which is an objective of financial reporting?
a. To provide information that is useful in making investing and credit decisions
b. To provide information that is useful to management
c. To provide information about the potential users
d. To provide information about ways to solve internal and external conflicts
about the entity
Which is an objective of financial reporting?
a. To provide information that is useful to management in making decisions
b. To provide information that clearly portrays non financial transactions
c. To provide information that is useful to assess the amount, timing, and
uncertainty of prospective cash receipts
d. To provide information that excludes claims against the resources
An objective of financial reporting is to provide
a. Information about the investors in the entity
b. Information about the liquidation value
c. Information that is useful in assessing cash flow prospects
d. Information that will attract new investors
Assessing cash flow prospects is interpreted to mean
a. Cash basis accounting is preferred over accrual basis
b. Information about the financial effects of cash receipts and cash payments is
generally considered the best indicator of ability to generate favorable cash flows
c. Over the long run, trends in revenue and expenses are generally more
meaningful than trends in cash receipts and disbursements
d. All of the choices are correct regarding assessing cash flow prospects
In measuring financial performance, accrual accounting is used because
a. Cash flows are considered less important
b. It provides a better indication of ability to generate cash flows than cash basis
c. It recognizes revenue when cash is received
d. It is one of the implicit assumptions
The most useful information in predicting future cash flows is
a. Information about current cash flows
b. Current earnings based on accrual accounting
c. Information regarding the accounting policies used
d. Information regarding the results obtained by using a wide variety of
accounting policies
The accrual basis of accounting is most useful for
a. Determining the amount of income tax liability
b. Predicting the short-term financial performance
c. Predicting the long-term financial performance
d. Determining the amount of dividends to be declared
The objective of financial reporting is based on
a. The need for conservatism
b. Reporting on management stewardship
c. Generally accepted accounting principles
d. The needs of the users of the information
Which statement is not true about financial reporting
a. Financial reporting shall provide information about entity resources, claims
against those resources and changes in them
b. Financial reporting shall not provide information useful in evaluating
management stewardship
c. Financial reporting shall provide information useful in investment, credit and
similar decision
d. Financial reporting shall provide information useful in assessing cash flow
prospects
Which of the following is not an objective of financial reporting
a. To provide information about an entity's assets and claims against those
assets
b. To provide information that is useful in assessing an entity's sources and uses
of cash
c. To provide information that is useful in lending and investing decisions
d. To provide information about the liquidation value of an entity
Financial reporting pertains to information about
a. Individual business entities, rather than to industries or an economy as a
whole or to members of society as consumers
b. Business industries, rather than to individual entities or an economy as a
whole or to members of society as consumers
c. Individual business entities, industries, and an economy as a whole, rather
than to
members of society as consumers
d. An economy as a whole and to members of society as consumers, rather than
to
individual entities or industries
Under the Revised Conceptual Framework, during a period when an entity is under the
direction of a particular management, financial reporting provides information about
a. Entity performance and management performance
b. Management performance but not entity performance
c. Entity performance but not management performance
d. Neither entity performance nor management performance
Chapter 3
QUALITATIVE CHARACTERISTICS
Qualitative characteristics are the qualities or attributes that make financial accounting
information useful to the users.
In deciding which information to include in financial statements, the objective is to ensure that
the information is useful to the users in making economic decisions.
Under the Conceptual Framework for Financial Reporting, qualitative characteristics are
classified into fundamental qualitative characteristics and enhancing qualitative characteristics.
Fundamental qualitative characteristics
The fundamental qualitative characteristics relate to the content or substance of financial
information.
The fundamental qualitative characteristics are relevance and faithful representation Information
must be both relevant and faithfully represented if it is to be useful.
Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of
a relevant phenomenon helps users make good decisions.
Application of qualitative characteristics
The most efficient and effective process of applying the fundamental qualitative characteristics
would usually be:
First, identify an economic phenomenon or transaction that has the potential to be
useful.
Second, identify the type of information about the phenomenon or transaction that would
be most relevant and can be faithfully represented.
Third, determine whether the information is available.
Relevance
In the simplest terms, relevance is the capacity of the information to influence a decision. To be
relevant, the financial information must be capable of making a difference in the decisions made
by users.
In other words, relevance requires that the financial information should be related or pertinent to
the economic decision.
Information that does not bear on an economic decision is useless.
To be useful, information must be relevant to the decision making needs of users.
For example, broadly, the statement of financial position is relevant in determining financial
position, and the income statement is relevant in determining performance.
More specifically, the earnings per share information is more relevant than book value per share
in determining the attractiveness of an investment.
Ingredients of relevance
Financial information is capable of making a difference in a decision if it has predictive value and
confirmatory value.
Financial information has predictive value if it can be used as an input to processes employed
by users to predict future outcome.
In other words, financial information has predictive value when it can help users increase the
likelihood of correctly or accurately predicting or forecasting outcome of events.
For example, information about financial position and past performance is frequently used in
predicting dividend and wage payments and the ability of the entity to meet maturing
commitments.
The net cash provided by operating activities is valuable in predicting loan payment or default.
Financial information has confirmatory value if it provides feedback about previous evaluations.
In other words, financial information has confirmatory value when it enables users confirm or
correct earlier expectations.
For example, a net income measure has confirmatory value if it can help shareholders confirm
or revise their expectation about an entity's ability to generate earnings.
Often, information has both predictive and confirmatory value. The predictive and confirmatory
roles of information are interrelated.
An example is an interim income statement which provides feedback about income to date and
serves as a basis for predicting the annual income.
The interim income statement for the first quarter shows net income of P2,000,000. This
information is the confirmatory value.
If this trend continues for the entire year, it is logical to assume that the net income after four
quarters or one year would be P8,000,000. This information is the predictive value.
Materiality
Materiality is a practical rule in accounting which dictates that strict adherence to GAAP is not
required when the items are not significant enough to affect the evaluation, decision and
fairness of the financial statements.
The materiality concept is also known as the doctrine of convenience.
Materiality is really a quantitative threshold linked very closely to the qualitative characteristic of
relevance The relevance of information is affected by its nature and materiality.
In other words, materiality is a subquality of relevance based on the nature or magnitude or both
of the items to which the information relates.
The Conceptual Framework does not specify a uniform quantitative threshold for materiality or
predetermine what could be material in a particular situation.
Materiality is a relativity
Materiality of an item depends on relative size rather than absolute size. What is material for
one entity may be immaterial for another.
An error of P500,000 in the financial statements of a multinational entity may not be important
but may be so critical for a small entity.
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. As
a general guide, an item is material if knowledge of it could reasonably affect or influence the
economic decision of the primary users of the financial statements.
New definition of materiality
The IASB provided the following new definition of materiality.
Information is material if omitting, misstating or obscuring it could reasonably be expected to
influence the economic decisions that primary users of general purpose financial statements
make on the basis of those statements which provide financial information about a specific
reporting entity.
In other words, an information is material if the omission, misstatement and obscuring of the
information could reasonably affect the econome decision of primary users.
The revised definition of materiality highlights three important aspects:
a. Could reasonably be expected to influence
b. Obscuring information c. Primary users
C. Primary users
Could reasonably be expected to influence
The could reasonably be expected to influence threshold adds an element of reasonability of
financial information on which economic decision is based.
By including the term could reasonably be expected to influence in the new definition, material
information shall be limited to the economic decision of primary users rather than to all users
which is too broad in scope.
Moreover, the could reasonably be expected to influence threshold insures that information
capable of influencing economic decision of the primary users shall be included in the financial
statements.
Obscuring information
Obscuring information is a new concept added to the new definition of materiality. Information is
obscured if presenting or communicating it would have a similar effect as omitting or misstating
the information.
Obscuring information means the presentation of financial information not readily understood or
not clearly expressed.
Obscuring information may be characterized by deliberate vagueness, ambiguity and
abstruseness. Examples of obscured material information are:
a. The language is vague or unclear.
b. The information is scattered throughout the financial statements.
c. Dissimilar items are aggregated inappropriately.
d. Similar items are disaggregated inappropirately.
Primary users
The new definition of materiality narrows the definition to primary users who are primarily
affected by general purpose financial statements.
The primary users include the existing and potential investors, lenders and other creditors.
The new definition specified that only primary users of financial statements are considered
because these groups are the users to whom general purpose financial statements are primarily
directed.
Such primary users cannot require reporting entities to provide information directly to them and
therefore must rely on general purpose financial reports for how much financial information is
needed. The other users include the employees, customers, government agencies and the
public in general.
Factors of materiality
Materiality depends on the magnitude and nature of the financial information. In the exercise of
judgment in determining materiality, the relative size and nature of an item are considered.
The size of the item in relation to the total of the group to which the item belongs is taken into
account.
For example, the amount of advertising in relation to total selling expenses, the amount of office
salaries to total administrative expenses, the amount of prepaid expenses to total current assets
and the amount of leasehold improvements to total property, plant and equipment.
The nature of the item may be inherently material because by its very nature it affects economic
decision. For example, the discovery of a P20,000 bribe is a material event even for a very large
entity.
Faithful representation
Faithful representation means that financial reports represent economic phenomena or
transactions in words and numbers. Stated differently, the descriptions and figures must match
what really existed or happened.
Simply worded, faithful representation means that the actual effects of the transactions shall be
properly accounted for and reported in the financial statements.
For example, if the entity reports purchases of P5,000,000 when the actual amount is
P8,000,000, the information would not be faithfully represented.
To record a sale of merchandise as miscellaneous income would not also be a faithful
representation of the sale. transaction.
Ingredients of faithful representation
To be a perfectly faithful representation, a depiction should have three characteristics, namely:
a. Completeness
b. Neutrality
c. Free from error
Completeness
Completeness requires that relevant information should be presented in a way that facilitates
understanding and avoids erroneous implication.
A complete depiction includes all information necessary for a user to understand the
phenomenon or transaction being depicted, including all necessary description and explanation.
Actually, to be complete, the financial statements shall be accompanied by notes to financial
statements.
The purpose of the notes is to provide the necessary disclosures required by Philippine
Financial Reporting Standards.
Standard of adequate disclosure
Completeness is the result of the standard of adequate disclosure or principle of full disclosure.
The standard of adequate disclosure means that all significant and relevant information leading
to the preparation of financial statements shall be clearly reported.
Adequate disclosure however does not mean disclosure of just any data.
The accountant shall disclose a material fact known to him which is not disclosed in the financial
statements but disclosure of which is necessary in order that the financial statements would not
be misleading.
The standard of adequate disclosure is best described by disclosure of any financial facts
significant enough to influence the judgment of informed users.
Neutrality
A neutral depiction is without bias in the preparation or presentation of financial information.
A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise
manipulated to increase the probability that financial information will be received favorably or
unfavorably by users.
In other words, to be neutral, the information contained in the financial statements must be free
from bias.
The financial information should not favor one party to the detriment of another party.
The information is directed to the common needs of many users and not to the particular needs
of specific users.
Neutrality is synonymous with the all-encompassing principle of fairness.
To be neutral is to be fair.
Prudence
The Revised Conceptual Framework has reintroduced the concept of prudence.
Prudence is the exercise of care and caution when dealing with the uncertainties in the
measurement process such that assets or income are not overstated and liabilities or expenses
are not understated.
Neutrality is supported by the exercise of prudence.
Conservatism
Conservatism is synonymous with prudence.
Conservatism means that when alternatives exist, the alternative which has the least effect on
equity should be chosen. In the simplest words, conservatism means "in case of doubt, record
any loss and do not record any gain."
For example, if there is a choice between two acceptable asset values, the lower figure is
selected. Accordingly, inventories are measured at the lower of cost and net realizable value.
Contingent loss is recognized as a "provision" if the loss is probable and the amount can be
reliably measured.
Contingent gain is not recognized but disclosed only.
It is to be emphasized that conservatism is not a license to deliberately understate net income
and net assets.
For example, if an entity has a cash of P500,000 and reports only P100,000, this is not
conservatism but fraud or inaccurate reporting.
Expressions of conservatism
"Anticipate no profit and provide for probable and measurable loss."
"In the matter of income recognition, the accountant takes the position that no matter how sure
the businessman might be in capturing the bird in the bush, he, the accountant, must see it in
the hand."
"Don't count your chicks until the eggs hatch".
Free from error
Free from error means there are no errors or omissions in the description of the phenomenon or
transaction.
Moreover, the process used to produce the reported information has been selected and applied
with no errors in the process.
In this context, free from error does not 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 an estimate.
Moreover, 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.
Measurement uncertainty
Measurement uncertainty arises when monetary amounts in financial reports cannot be
observed directly and must, instead be estimated.
Measurement uncertainty can affect faithful representation if the level of uncertainty in providing
an estimate is high.
However, the use of reasonable estimate is an essential part of providing financial information
and does not undermine the usefulness of the financial information.
As long as the estimate is clearly and accurately described and explained, even a high level of
measurement uncertainty does not affect the usefulness of the financial information.
Substance over form
If information is to represent faithfully the transactions and other events it purports to represent,
it is necessary that the transactions and events are accounted in accordance with their
substance and not merely their legal form.
The economic substance of transactions and events are usually emphasized when economic
substance differs from legal form.
Substance over form is not considered a separate component of faithful representation because
it would be redundant.
Faithful representation inherently represents the substance of an economic phenomenon or
transaction rather than merely representing the legal form.
Representing a legal form that differs from the economic substance of the underlying economic
phenomenon or transaction could not result in a faithful representation.
Example of substance over form
An example is when the lessee leased property from the lessor.
The terms of the lease provide that the lease transfers ownership of the asset to the lessee by
the end of the lease term.
In form, the contract is a lease as popularly understood.
But in substance, in reality, if the "transfer of ownership provision" is to be considered, the real
intent of the parties is an installment purchase of an asset by the lessee from the lessor.
Accordingly, the lessee shall record an acquisition of right of use asset and set up a liability to
the lessor.
The periodic rental is conceived as an installment payment representing interest and principal.
Enhancing qualitative characteristics
The enhancing qualitative characteristics relate to the presentation or form of the financial
information.
The enhancing qualitative characteristics are intended to increase the usefulness of the financial
information that is relevant and faithfully represented.
The enhancing qualitative characteristics are comparability, understandability, verifiability and
timeliness.
Relevant and faithfully represented financial information is useful but the information would be
most useful if it is comparable, understandable, verifiable and timely.
Comparability
Comparability means the ability to bring together for the purpose of noting points of likeness and
difference.
Comparability is the enhancing qualitative characteristic that enables users to identify and
understand similarities and dissimilarities among items.
Comparability may be made within an entity or between and across entities.
Comparability within an entity is the quality of information that allows comparisons within a
single entity through time or from one accounting period to the next.
Comparability within an entity is also known as horizontal comparability or intracomparability.
Comparability between and across entities is the quality of information that allows comparisons
between two or more entities engaged in the same industry.
Comparability across entities is also known as intercomparability or dimensional comparability.
For information to be comparable, like things must look alike and different things must look
different.
Comparability is not enhanced by making unlike things look alike or making like things look
different.
Consistency
Implicit in the qualitative characteristic of comparability is the principle of consistency.
Consistency is not the same as comparability.
In a broad sense, consistency refers to the use of the same method for the same item, either
from period to period within an entity or in a single period accross entities.
Comparability is the goal and consistency helps to achieve that goal.
In a limited sense, consistency is the uniform application of accounting method from period to
period within an entity.
On the other hand, comparability is the uniform application of accounting method between and
across entities in the same industry.
An entity cannot use the FIFO method of inventory valuation in one year, the average method
method in the next year, again the FIFO 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 would result to more useful and meaningful information, then such change shall be
made.
But there shall be full disclosure of the change and the peso effect thereof.
It is inappropriate for an entity to leave accounting policies unchanged when better and
acceptable alternatives exist.
Understandability
Understandability requires that financial information must be comprehensible or intelligible if it is
to be most useful. Accordingly, the information should be presented in a form and expressed in
terminology that a user understands.
Classifying, characterizing and presenting information "clearly and concisely" makes it
understandable.
An essential quality of the information provided in financial statements is that it is readily
understandable by users.
But the complex economic activities make it impossible to reduce the financial information to the
simplest terms.
Accordingly, the users shall have an understanding of the complex economic activities, the
financial accounting process and the terminology in the financial statements.
Financial statements cannot realistically be understandable to everyone.
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 phenomena or transactions.
Understandability is very essential because a relevant and faithfully represented information
may prove useless if it is not understood by users.
Verifiability
Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation. In other words, verifiability implies consensus.
The financial information is verifiable in the sense that it is supported by evidence so that an
accountant that would look into the same evidence would arrive at the same economic decision
or conclusion.
Verifiable financial information provides results that would be substantially duplicated by
measurers using the same measurement method.
Accordingly, verifiability helps assure users that information represents the economic
phenomenon or transaction it purports to représent.
Verifiability is synonymous with objectivity.
Types of verification
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 inputs using the same methodology.
An example is verifying the carrying amount of inventory by checking the inputs in quantities
and costs, and recalculating the ending inventory using the same cost flow assumption, such as
first-in, first-out.
Timeliness
Timeliness means that financial information must be available or communicated early enough
when a decision is to be made. Relevant and faithfully represented financial information
furnished after a decision is made is useless or of no value."
For example, the most important attribute of quarterly or interim financial information is its
timeliness.
Generally, the older the information, the less useful. However, some information may continue to
be timely long after the end of reporting period because some users may need to identify and
assess trends.
Timeliness enhances the truism that without knowledge of the past, the basis for prediction will
usually be lacking and without interest in the future, knowledge of the past is sterile.
What happened in the past would become the basis of what would happen in the future.
Cost constraint on useful information
Cost is a pervasive constraint on the information that can be provided by financial reporting.
Reporting financial information imposes cost and it is important that such cost is justified by the
benefit derived from the financial information.
In other words, the cost constraint is a consideration of the cost incurred in generating financial
information against the benefit to be obtained from having the information.
The benefit derived from the information should exceed the cost incurred in obtaining the
information.
However, the evaluation of the cost constraint is substantially a judgmental process.
Assessing whether the cost of reporting outweighs or falls short of the benefit is difficult to
measure and becomes a matter of professional judgment.
What are the attributes that make the
information provided in the financial
statements useful to the
readers?
a. Qualitative characteristics of financial
information
b. Quantitative characteristics of financial
information
c. Elements of financial statements
d. Objectives of financial reporting
2. Qualitative Characteristics
a. are considered either fundamental or
enhancing.
b. contribute to the decision-usefulness of
financial reporting information.
c. distinguish better information from inferior
information for decision-making purposes.
d. All of the choices are correct.
3. The fundamental qualitative
characteristics are
a. Relevance and faithful representation
b. Relevance, faithful representation and
materiality
c. Relevance and reliability
d. Faithful representation and materiality
4. Accounting information is considered
relevant when it
a. Can be depended on to represent the
economic conditions and events that is
intended to represent.
b. Is capable of making a difference in a
decision.
c. Is understandable by reasonably
informed users
of accounting information.
d. Is verifiable and neutral.
5. The ingredients of relevant financial
information are
a. Predictive value and confirmatory value
b. Predictive value, confirmatory value and
timeliness
c. Predictive value, confirmatory value and
materiality
d. Predictive value, confirmatory value,
timeliness and materiality
6. What is the quality of information that
gives
assurance that is reasonably free of error
and bias?
a. Relevance
b. Faithful representation
c. Verifiability
d. Neutrality
7. Which of the following is the best
description of “faithful representation” in
relation to information in financial
statements?
a. Influence on the economic decision of
users
b. Inclusion of a degree of caution
c. Freedom from material error
d. Comprehensibility to users
8. To achieve faithful representation, the
financial
statements
a. Must have predictive and confirmatory
value.
b. Must be complete, neutral and
reasonably free from error.
c. Are understandable, comparable,
verifiable and timely.
d. Must possess all of these.
9. The financial accounting information is
directed
toward the common needs of users and is
independent of presumptions about
particular
needs and desires of specific users.
a. Relevance
b. Verifiability
c. Neutrality
d. Completeness
10. In the event of conflict between the
economic substance of a transaction and
the legal form, the economic substance
shall prevail.
a. Form over substance
b. Substance over form
c. Relevance
d. Completeness
Problem 3-2 (IAA)
1. The enhancing qualitative characteristics
of financial information are
a. Comparability and understandability
b. Verifiability and timeliness
c. Comparability, understandability and
verifiability
d. Comparability, understandability,
verifiability and timeliness
2. Financial information exhibits consistency
when
a. Accounting procedures are adopted
which smooth net income and make results
consistent between years.
b. Gains and losses are shown separately
on the income statement.
c. Accounting entities give similar events the
same accounting treatment each period.
d. Expenditures are reported as expenses.
3. When information about two different
entities engaged in the same industry has
been prepared and presented in similar
manner, the information exhibits the
enhancing qualitative characteristic of
a. Relevance
b. Faithful representation
c. Consistency
d. Comparability
4. The characteristic that is demonstrated
when a high degree of consensus can be
secured among independent measures
using the same measurement method is
a. Relevance
b. Understandability
c. Verifiability
d. Neutrality
5. Which of concept of accounting holds
that, to the maximum extent possible,
financial statements shall be based on
arm’s length transactions?
a. Revenue realization
b. Verifiability
c. Monetary unit
d. Matching
6. An entity issuing the annual financial
reports within one month after the end of the
reporting period is an example of which
enhancing quality of accounting
information?
a. Neutrality
b. Timeliness
c. Predicative value
d. Representational faithfulness
7. Allowing entities to estimate rather than
physically count inventory at interim periods
is an example of tradeoff between
a. Verifiability and comparability
b. Timeliness and comparability
c. Timeliness and verifiability
d. Neutrality and consistency
8. Which qualitative characteristic of
financial information requires that
information should not be biased in favor of
one group of users to the detriment of
others?
a. Relevance
b. Free from error
c. Completeness
d. Neutrality
9. For information to be useful, the linkage
between the users and the decision made is
a. Relevance
b. Faithful representation
c. Understandability
d. Verifiability
10. Which statement is true in relation to the
enhancing quality of understandability?
a. Users have a reasonable knowledge of
business and economic activities and
review the information with reasonable
diligence.
b. Users are expected to have significant
business knowledge.
c. Financial statements shall exclude
complex matters.
d. Financial statements shall be free from
material error.
Problem 3-3 (IAA)
1. The overriding qualitative characteristic of
accounting information is
a. Relevance
b. Understandability
c. Faithful representation
d. Decision usefulness
2. Which of the following terms best
describes information that influences the
economic decision of users
a. Reliable
b. Prospective
c. Relevant
d. Understandable
3. What is the quality of information that
enables users to better forecast future
operations?
a. Faithful representation
b. Materiality
c. Comparability
d. Relevance
4. According to the Conceptual Framework,
predictive value and confirmatory value are
ingredients of
a. Relevance
b. Faithful representation
c. Understandability
d. Comparability
5. Which term best describes information in
financial statements that is neutral?
a. Understandable
b. Comparable
c. Relevant
d. Unbiased
6. What is meant by comparability when
discussing financial accounting information?
a. Information has predictive value and
confirmatory value.
b. Information is reasonably free from error.
c. Information is measured and reported in a
similar fashion across entities.
d. Information is timely.
7. What is meant by consistency when
discussing financial accounting information?
a. Information 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.
8. Which of the following is not an
enhancing
qualitative characteristic?
a. Understandability
b. Profit-oriented
c. Timeliness
d. Comparability
9. Changing the method on inventory
valuation should be reported in the financial
statements under what enhancing quality of
accounting information?
a. Understandability
b. Verifiability
c. Timeliness
d. Comparability
10. When an entity applies the same
accounting treatment to similar events from
period to period, the entity is exhibiting
which of the following qualities?
a. Verifiability
b. Consistency
c. Predictive value
d. All of the choices are correct
Problem 3-4 (IAA)
1. When there is agreement between a
measure or description and the
phenomenon it purports to represent, the
information possesses which characteristic?
a. Verifiability
b. Predictive value
c. Faithful representation
d. Timeliness
2. The qualitative characteristic of faithful
representation includes
a. Predictive value
b. Neutrality
c. Confirmatory value
d. Timeliness
3. Enhancing qualitative characteristics of
accounting information include all of the
following, except
a. Timeliness
b. Materiality
c. Comparability
d. Verifiability
4. The enhancing quality of
understandability means that information
should be understood by
a. Those who are experts in the
interpretation of
financial information.
b. Those who have reasonable
understanding of business and economic
activities.
c. Financial analysts
d. CPAs
5. Enhancing qualitative characteristics of
accounting information include
a. Relevance and comparability
b. Comparability and timeliness
c. Understandability and relevance
d. Neutrality and comparability
c. Consensus
d. Legal verdict
8. When an entity has started placing its
quarterly financial statements on its web
page, thereby reducing ten days the time to
get information to investors and creditors,
the qualitative concept involved is
a. Comparability
b. Consistency
c. Timeliness
d. Faithful representation
9. When an entity changed the inventory
valuation method, which characteristic is
jeopardized by this change?
a. Comparability
b. Representational faithfulness
c. Consistency
d. Feedback value
10. Recognizing expected losses
immediately but deferring expected gains is
an example of
a. Materiality
b. Conservatism
c. Cost effectiveness
d. Timeliness
Problem 3-5 (IAA)
6. When four different competent
accountants independently agree on the
amount and method of reporting an
economic event, what is the concept
demonstrated?
a. Reliability
b. Comparability
c. Completeness
d. Verifiability
7. According to the conceptual framework,
verifiability implies
a. Legal evidence
b. Logic
1. Which statement about materiality is
true?
a. An item must make a difference or it need
not be disclosed.
b. Materiality is a matter of relative size or
importance.
c. An item is material if the inclusion or
omission would influence the judgment of a
reasonable person.
d. All of these statements are true about
materiality.
2. An item would be considered material
when
a. The expected benefits exceed additional
costs.
b. The impact on earnings is greater than
10%.
c. The standard definition of materiality is
met.
d. The omission or misstatement of the
amount would make a difference to the
users.
3. The Conceptual Framework includes
which constraint?
a. Prudence
b. Conservatism
c. Cost
d. All of these are constraints
4. Which best describes the cost benefit
constraint?
a. The benefit of the information must be
greater than the cost of providing it.
b. Financial information should be free from
cost to users.
c. Cost of providing financial information is
not always evident or measurable but must
be disclosed.
5. What is an enhancing quality of
accounting information?
a. Information must be decision-useful to all
users.
b. General-purpose financial reporting is the
primary source of information for statement
users.
c. Users need reasonable knowledge of
business and financial accounting matters
to understand the information contained in
financial statements.
d. All of the choices are correct.
Problem 3-6 (AICPA)
1. The ability through consensus among
measures to ensure that information
represents what it purports to represent is
an example of the concept of
a. Relevance
b. Verifiability
c. Comparability
d. Feedback value
2. Which of the following accounting
concepts states that an accounting
transaction shall be supported by sufficient
evidence to allow two or more qualified
individuals to arrive at essentially similar
conclusion?
a. Conservatism
b. Objectivity
c. Periodicity
d. Stable monetary unit
3. Objectivity is assumed to be achieved
when a 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
between two independent parties.
d. Allocates revenue and expenses in a
rational and systematic manner.
4. The principle of objectivity includes the
concept of
a. Summarization
b. Classification
c. Conservatism
d. Verifiability
5. Proponents of historical cost maintain
that
statements prepared using historical cost
are more
a. Objective
b. Relevant
c. Indicative of purchasing power
d. Conservative
6. The consistency standard requires that
a. Expenses should be reported when
incurred.
b. The effect of accounting changes upon
income should be properly disclosed.
c. Gains and losses should not be
recognized.
d. Accounting procedures should be
adopted when the result is a consistent rate
of return.
7. Which of the following relates to both
relevance and faithful representation?
a. Comparability
b. Feedback value
c. Neutrality
d. Free from error
8. Which of the following situations violates
the concept of faithful representation?
a. Financial statements were issued nine
months late.
b. Data on segments having the same
expected risks are reported to analysts
estimating future profit.
c. Financial statements included an item of
property, plant and equipment with carrying
amount increased to management estimate
of market value.
d. Management reports to shareholders
regularly refer to new projects undertaken.
9. What is the underlying concept governing
the GAAP pertaining to recording gain
contingencies?
a. Conservatism
b. Relevance
c. Consistency
d. Reliability
10. The usefulness of providing information
in financial statements is subject to the
constraint of
a. Consistency
b. Cost-benefit
c. Reliability
d. Representational faithfulness
Problem 3-7 Identification (ACP)
1. Information that has no bearing on an
economic decision to be made is useless.
Relevance
2. It is the ability to bring together for the
purpose of noting points of likeness and
difference.
Comparability
3. It requires that users have some
reasonable of the complex economic
activities of entities, the accounting process
and the technical terminology in the
statements.
Understandability
4. Preparers of statements should not try to
increase the usefulness of the information to
a few users to the detriment of others who
may have opposing interests.
Neutrality
5. In case of conflict between economic
substance and legal form of a transaction,
the economic substance shall prevail.
Substance over form
6. Small expenditures for tools are
expensed immediately.
Materiality
7. When on doubt, recognize all losses and
don’t recognize gains.
Conservatism
8. The information should be presented in a
manner that facilitates understanding and
avoids erroneous implication.
Completeness
9. It is the capacity of the information to
influence a decision.
Relevance
10. The description and numbers or figures
must watch what really existed or
happened.
Faithful Representation
11. The financial statements shall be
accompanied by notes to financial
statements.
Completeness
12. There are no errors or omissions in the
description of the phenomenon.
Free from error
13. It is the goal achieved by consistency.
Comparability
14. This enhancing qualitative characteristic
implies consensus.
Verifiability
15. The older the information, the less
useful.
Timeliness
fundamentals that lead to consistent
standards.
TRUE
2. Fundamental qualitative characteristics of
financial accounting information are either
relevant or prudent.
FALSE
3. An enhancing qualitative characteristic is
confirmatory value.
FALSE
4. A fundamental qualitative characteristic is
Understandability.
FALSE
5. To be a faithful representation, an
information must be predictive and
confirmatory.
FALSE
6. An enhancing quality of financial
accounting information is comparability.
TRUE
7. Applying different accounting treatment to
similar event from period to period is
violation of verifiability.
FALSE
8. The idea of consistency does not mean
that entities cannot switch from one
accounting method to another.
TRUE
9. Financial statement users are assumed
to have no reasonable knowledge of
business and financial accounting matters.
FALSE
Problem 3-8 True or False (IAA)
1. A coherent framework is a coherent
system of interrelated objectives and
10. Entities consider only quantitative
factors in determining whether an item is
material.
FALSE
11. Neutrality and predictive value are
characteristics of relevant financial
information.
FALSE
12. The tendency to recognize favorable
events early is an example of conservatism.
FALSE
13. The Conceptual Framework focuses
primarily on the needs of internal users of
financial information.
FALSE
14. The overall objective of financial
reporting is to provide information for
making economic decisions.
TRUE
15. Once an accounting method is adopted,
it should never be changed
FALSE.
Chapter 4
GENERAL OBJECTIVE OF FINANCIAL STATEMENTS
Financial statements provide information about economic resources of the reporting entity,
claims against the entity and changes in the economic resources and claims.
Financial statements provide financial information about an entity's assets, liabilities, equity,
income and expenses useful to users of financial statements in:
a. Assessing future cash flows to the reporting entity.
b. Assessing management stewardship of the entity's economic resources.
The financial information is provided in the following:
1. Statement of financial position, by recognizing assets, liabilities and equity
2. Income statement, by recognizing income and expenses
3. Statement of cash flows, by recognizing cash flows from operating, investing and
financing activities
4. Statement of changes in equity, by recognizing contributions from equity holders and
distributions to equity holders
5. Notes to financial statements, by recognizing disclosures required by accounting
standards
Types of financial statements
The Revised Conceptual Framework recognizes three types of financial statements.
1. Consolidated financial statements are the financial statements prepared when the
reporting entity comprises both the parent and its subsidiaries.
2. Unconsolidated financial statements are the financial statements prepared when the
reporting entity is the parent alone.
3. Combined financial statements are the financial statements when the reporting entity
comprises two or more entities that are not linked by a parent and subsidiary
relationship.
Consolidated financial statements
Consolidated financial statements provide information about the assets, liabilities, equity,
income and expenses of both the parent and its subsidiaries as a single reporting entity.
The parent is the entity that exercises control over the subsidiaries.
Consolidated information is useful for existing and potential investors, lenders and other
creditors of the parent in their assessment of future net cash inflows to the parent.
This is because net cash inflows to the parent include distributions to the parent from its
subsidiaries.
Consolidated financial statements are not designed to provide separate information about the
assets, liabilities equity, income and expenses of a particular subsidiary.
A subsidiary's own financial statements are designed to provide such information.
Unconsolidated financial statements
Unconsolidated financial statements are designed to provide information about the parent's
assets, liabilities, income and expenses and not about those of the subsidiaries.
Such information can be useful to the existing and potential investors, lenders and other
creditors of the parent because a claim against the parent typically does not give the holder of
that claim against subsidiaries.
Information provided in unconsolidated financial statements is typically not sufficient to meet the
requirement needs of primary users.
Accordingly, when consolidated financial statements are required, unconsolidated financial
statements cannot serve as substitute for consolidated financial statements.
Combined financial statements
Combined financial statements provide financial information about the assets, liabilities, equity,
income and expenses of two or more entities not linked with parent and subsidiary relationship.
Reporting entity
A reporting entity is an entity that is required or chooses to prepare financial statements. The
reporting entity can be a single entity or a portion of an entity, or can comprise more than one
entity.
A reporting entity is not necessarily a legal entity.
Accordingly, the following can be considered a reporting entity:
a. Individual corporation, partnership or proprietorship
b. The parent alone
c. The parent and its subsidiaries as single reporting entity
d. Two or more entities without parent and subsidiary relationship as a single reporting
entity
e. A reportable business segment of an entity
Reporting period
The reporting period is the period when financial statements are prepared for general purpose
financial reporting.
Financial statements may be prepared on an interim basis, for example, three months, six
months or nine months.
Interim financial statements are not required but optional.
However, financial statements must be prepared on an annual basis or a period of twelve
months.
Financial statements are prepared for a specified period of time and provide information about:
a. Assets, liabilities and equity at the end of the reporting period.
b. Income and expenses during the reporting period.
To help users of financial statements to identify and assess change in trends, financial
statements also provide comparative information for at least one preceeding reporting period.
Financial statements may include information about transactions and other events that occurred
after the end of reporting period if the information is necessary to meet the general objective of
financial statements.
UNDERLYING ASSUMPTIONS
Accounting assumptions or accounting postulates are the basic notions or fundamental
premises on which the accounting process is based.
Like a building structure that requires a solid foundation to avoid or prevent future collapse and
provide room for expansion, and so with accounting. Accounting assumptions serve as the
foundation or bedrock of accounting in order to avoid misunderstanding but rather enhance the
understanding and usefulness of the financial statements.
The Conceptual Framework for Financial Reporting mentions only one assumption, namely
going concern.
However, implicit in accounting are the basic assumptions of accounting entity, time period and
monetary unit.
Going concern
The going concern or continuity assumption means that in the absence of evidence to the
contrary, the accounting entity is viewed as continuing in operation indefinitely.
In other words, the financial statements are normally prepared on the assumption that the entity
will continue in operations for the foreseeable future.
The going concern postulate is the very foundation of the cost principle. Thus, assets are
normally recorded at cost. As a rule, market values are ignored. However, some new standards
require measurement of certain assets at fair value..
If there is evidence that the entity would experience large and persistent losses or that the
entity's operations are to be terminated, the going concern assumption is abandoned.
In this case, the users of the statements will have a great interest in the amount of cash that will
be generated from the entity's assets in the short term.
Accounting entity
In financial accounting, the accounting entity is the specific business organization, which may be
a proprietorship. partnership or corporation.
Under this assumption, the entity is separate from the owners, managers, and employees who
constitute the entity. Accordingly, the transactions of the entity shall not be merged with the
transactions of the owners.
The reason for the entity assumption is to have a fair presentation of financial statements.
The personal transactions of the owners shall not be allowed to distort the financial statements
of the entity.
For example, the cash invested by the proprietor is treated as an asset of the proprietorship.
If an enterprising entrepreneur owns department store, restaurant and bookstore, separate
statements shall be prepared for each business in order to determine which business is
profitable.
Each business is an independent accounting entity.
When a major shareholder of a corporation borrows money from a bank on his own personal
account, the loan is a liability of the shareholder alone and not of the corporation.
The shareholder is not the corporation and the corporation is not the shareholder.
However, where parent and subsidiary relationship exists, consolidated statements for the
affiliates are usually made because for practical and economic purposes, the parent and the
subsidiary are a single economic entity.
The consolidation, however, does not eliminate the legal boundary segregating the affiliated
entities.
Accounting will continue to be done separately for each entity.
Time period
A completely accurate report on the financial, position and performance of an entity cannot be
obtained until the entity is finally dissolved and liquidated. Only then can the final net income
and networth of the entity be determined precisely.
However, users of financial information need timely information for making an economic
decision.
It becomes necessary therefore to prepare periodic reports on financial position, performance
and cash flows of an entity.
The time period assumption requires that the indefinite life of an entity is subdivided into
accounting periods which are usually of equal length for the purpose of preparing financial
reports on financial position, performance and cash flows.
By convention, the accounting period or fiscal period is one year or a period of twelve months.
The one-year period is traditionally the accounting period because usually it is after one year
that government reports are required.
The accounting period may be a calendar year or a natural business year.
A calendar year is a twelve-month period that ends on December 31.
A natural business year is a twelve-month period that ends on any month when the business is
at the lowest or experiencing slack season.
Monetary unit
The monetary unit assumption has two aspects, namely quantifiability and stability of the peso.
The quantifiability aspect means that the assets, liabilities, equity, income and expenses should
be stated in terms of a unit of measure which is the peso in the Philippines.
How awkward to see financial statements without any common unit of measure. Such
statements would be largely unintelligible and incomprehensible.
The stability of the peso assumption means that the purchasing power of the peso is stable or
constant and that its instability is insignificant and therefore may be ignored.
The stable peso postulate is actually an amplification of the going concern assumption so much
so that adjustments are unnecessary to reflect any changes in purchasing power.
The accounting function to account for nominal pesos only and not for constant pesos or
changes in purchasing power.
In today's world, the assumption that the peso is a stable measure over time is not necessarily
valid.
Consider an equipment that was imported 10 years ago from the United States for $100,000
when the exchange rate was P35 to $1 or an equivalent of P3,500,000.
If the same equipment is purchased now and assuming there is no change in the $100,000
purchase price, the replacement cost in terms of pesos would be in the vicinity of P5,000,000,
considering a current exchange rate of P50 to $1.
Obviously, there is a significant gap between historical cost and current replacement cost.
In this regard, an entity may choose the revaluation model as an accounting policy.
Chapter 4 Answers
1. General objective financial Statements
provide information about economic
resources of the reporting entity, claims
against the entity and changes in the
economic resources and claims
2. Reporting Entity
an entity required or chooses to prepare
financial statements
3. Reporting Entity
All of these: can be a single entity or a
portion of an entity, or can comprise more
than one entity
4. Consolidated Financial Statements
financial statements prepared when the
reporting entity comprises both the parent
and its subsidiaries
5. Combined Financial Statements
financial statements prepared when the
reporting entity comprises two or more
entities that are not linked by a parent and
subsidiary relationship
6. Which ONE of the following statements
best describes the term 'going concern'?
1) When current liabilities of an entity
exceed current assets
2) The ability of the entity to continue in
operation for the foreseeable future
3) The potential to contribute to the flow of
cash and cash equivalents to the entity
4) The expenses of an entity exceed its
income
7. Which of the following is an implication of
the going concern assumption?
a. the historical cost principle is credible
b. depreciation and amortization policies are
justifiable and appropriate
c. the current-noncurrent classification of
assets and liabilities is justifiable and
significant
d. all of these
8. The relatively stable economic, political
and social environment supports
a. Conservatism
b. Materiality
c. Timeliness
d. Going concern
9. Which of the following is not a basic
assumption underlying financial accounting?
a. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Historical cost assumption
10. Which basic assumption may not be
followed when an entity in bankruptcy
reports financial results?
a. Economic entity
b. Going concern
b. Periodicity
c. Monetary unit
The Conceptual Framework deals with all of
the following, except
a. The objective of financial reporting
b. The qualitative characteristics of useful
financial information
c. The definition, recognition and
measurement of the elements of financial
statements
d. Supplementary information
Which of the following statements is true
concerning the Conceptual Framework for
Financial Reporting?
a. It is not a reporting standard and does not
define standard for any particular
measurement or disclosure issue.
b. It is concerned with general purpose fin
statements including consolidated fin
statements.
c. Nothing in the framework overrides any
specific PFRS.
d. All are true.
The Conceptual Framework deals with all of
the following, except
a. The objective of financial reporting
b. The qualitative characteristics of useful
financial information
c. The definition, recognition and
measurement of the elements of financial
statements
d. Supplementary information
Which of the following statements is true
concerning the Conceptual Framework for
Financial Reporting?
a. It is not a reporting standard and does not
define standard for any particular
measurement or disclosure issue.
b. It is concerned with general purpose fin
statements including consolidated fin
statements.
c. Nothing in the framework overrides any
specific PFRS.
d. All are true.
Which is not a purpose of the Conceptual
Framework?
a. to assist FRSC in developing accounting
standards that will represent Philippine
GAAP
b. to assist FRSC in the review and
adoption of existing international accounting
standards
c. to assist auditors in forming an opinion as
to whether fin statements conform with Phil.
GAAP
d. to assist BOA in promulgating rules and
regulations affecting the practice of public
accountancy
Which is a basic purpose of the Conceptual
Framework?
a. to assist users of fin statements in
interpreting the information contained in the
financial statements
b. to provide information to those interested
in the work of FRSC in the formulation of
PFRS
c. to assist preparers of fin statements in
applyng accounting standards
d. All of these
This is a complete, comprehensive and
single document promulgated by IASB
establishing the concepts that underlie
financial reporting.
a. Conceptual Framework for Financial
Reporting
b. Conceptual Framework for Financial
Statements
c. Conceptual Framework for Business
Entities
d. Conceptual Framework
What is the authoritative status of the
Conceptual Framework?
a. The Conceptual Framework has the
highest level of authority.
b. In the absence of a standard or an
interpretation that specifically applies to a
transaction, the Conceptual Framework
shall prevail.
c. In the absence of a standard or an
interpretation that specifically applies to a
transaction, management shall consider the
applicability of the Conceptual Framework in
developing and applying an accounting
policy that results in information that is
relevant and reliable.
d. The Conceptual Framework applies only
when the IASB develops new or revised
standards.
As regards the relationship between IFRS
and the Conceptual Framework, which of
the following is true?
I. The Conceptual Framework is a reporting
standard.
II. In case of conflict, the requirements of
the Conceptual Framework prevail over
those of the relevant IFRS.
a. I only
b. II only
c. Both
d. Neither
The Conceptual Framework is intended to
establish
a. GAAP
b. The meaning of "present fairly in
accordance with GAAP"
c. The objectives and concepts for use in
developing standards of financial
accounting and reporting
d. The hierarchy of sources of GAAP
The underlying theme of the Conceptual
Framework is
a. Decision usefulness
b. Understandability
c. Timeliness
d. Comparability
The Conceptual Framework should
a. Lead to uniformity of financial statements
among entities within the same industry
b. Eliminate alternative accounting
principles
c. Guide MNCs in developing generally
accepted auditing standards
d. Define the basic objective, terms and
concepts of accounting
What is a benefit of having a Conceptual
Framework?
a. To enable the accountancy profession to
more quickly solve emerging practical
problems.
b. To provide information from which to build
more useful standards.
c. To enable standard setting body to issue
more useful and consistent
pronouncements over time.
d. All of these.
Which is not a purpose of the Conceptual
Framework?
a. Provide definitions of key terms and
concepts
b. Provide specific guidelines for resolving
situations not covered by existing
accounting standards
c. Assist accountants in selecting among
alternative accounting and reporting
methods
d. Assist IASB in the standard-setting
process
In the Conceptual Framework for Financial
reporting, what provides the "why" of
accounting?
a. Measurement and recognition concept
b. Qualitative characteristic of accounting
information
c. Element of financial statement
d. Objective of financial reporting
Which of the following is not a benefit
associated with the Conceptual
Framework?
a. A Conceptual Framework should
increase financial statement users'
understanding and confidence in financial
reporting.
b. Practical problems should be more
quickly solvable by reference to an existing
Conceptual Framework.
c. A coherent set of accounting standards
and rules should result.
d. Business entities will need far less
assistance from accountants because the
financial reporting process will be quite easy
to apply.
Which is an important characteristic of the
Conceptual Framework?
I. To enable the accountancy profession to
more quickly solve emerging practical
problems.
II. To provide a foundation from which to
build more useful financial accounting
standards.
a. I only
b. II only
c. Both
d. Neither
Which of the following is not true concerning
the Conceptual Framework?
I. It should be a basis for standard setting.
II. The Conceptual Framework should allow
practical problems to be solved more
quickly.
III. It should be based on fundamental truth
derived from the law of nature.
a. II only
b. III only
c. II and III only
d. I and II only
A soundly Conceptual Framework should
I. Increase financial statements users'
understanding and confidence in financial
reporting
II. Enhance comparability of financial
statements across entities.
III. Allow new and emerging practical
problems to be solved more quickly.
a. I only
b. I and II only
c. I and III only
d. I, II, III
The primary users of financial statements
include
a. Existing and potential investors
b. Existing and potential lenders and other
creditors
c. User group such as employees,
customers, governments and their
agencies, and the public
d. Existing and potential investors, lenders,
and other creditors
The users of financial reports include
a. Creditors
b. Creditors and government agencies
c. Creditors and unions
d. Creditors, government agencies and
unions
Which of the following is an internal user of
financial information?
a. BOD
b. Shareholder
c. Bondholder
d. Creditor with a long-term contract
These users require information on risk and
return on investment
a. Investors
b. Employees
c. Lenders
d. Customers
These users are interested in information
about the profitability and stability of an
entity in order to assess the ability of the
entity to provide remuneration, retirement
benefits and employment opportunities.
a. Customers
b. The public
c. Government and their agencies
d. Employees
These users are interested in information
about the continuance of an entity when
they have a long-term involvement with or
are dependent on the entity.
a. Customers
b. Employees
c. Trade unions
d. Suppliers
These users are interested in information in
order to regulate the activities of an entity,
determine taxation policies and provide a
basis for national statistics.
a. Government and their agencies
b. Major organization of users
c. BIR
d. Department of Finance
These users need information on trends and
recent developments where an entity makes
a substantial contribution to the local
economy providing employment and using
local suppliers.
a. The public
b. Government and their agencies
c. Finance entities
d. Private entities
Which of the following in relation to
information needs is true?
I. Information that meets the need of
specified primary users is likely to meet the
needs of other users, such as employees,
customers, government and their agencies,
and the public.
II. The management is also interested in
financial information but it need not rely on
general purpose financial reports because it
can access additional information internally.
a. I only
b. II only
c. Both
d. Neither
These users are interested in information
that enables them to assess whether their
loans, the related interest thereon, and
other amounts owing to them will be paid
when due.
a. Lenders and other creditors
b. Borrowers
c. Trade creditors
d. Owners
What is the objective of financial reporting?
a. To provide information about the financial
position and financial performance of an
entity
b. To provide information about an entity
that is useful to existing and potential
investors, lenders, and other creditors in
making decisions about providing resources
to the entity
c. To prepare a statement of financial
position, a statement of comprehensive
income and a statement of cash flows
d. To prepare financial statements in
accordance with all applicable standards
and interpretations
The overall objective of financial reporting is
to provide information
a. That is useful for decision making
b. About assets, liabilities and equity of an
entity
c. About financial performance during a
period
d. That allows owners to assess
management performance
Which is an objective of financial reporting?
a. to provide information that is useful to
management in making decisions
b. to provide information that clearly
portrays non-financial transactions
c. to provide information that is useful to
assess the amounts, timing and uncertainty
of of prospective cash receipts
d. to provide information that excludes
claims against the resources
One objective of financial reporting is to
provide
a. Information about the investors in the
entity
b. Information about the liquidation value of
the resources held by the entity
c. Information that is useful in assessing
cash flow prospects
d. Information that will attract new investors
An objective of financial reporting is
"assessing cash flow prospects" which is
interpreted to mean
a. Cash basis accounting is preferred over
accrual basis of accounting.
b. Information about the financial effects of
cash receipts and cash payments is
generally considered the best indicator of
ability to generate favorable cash flows.
c. Over the long run, trends in revenue and
expenses are generally more meaningful
than trends in cash receipts and
disbursements.
d. All of these.
Which of the following best describes
"financial performance"?
a. The revenue, expenses and net income
or loss for a period
b. The assets, liabilities and equity
c. The total assets minus total liabilities
d. The total cash inflows minus total cash
outflows
In measuring financial performance, accrual
accounting is used because
a. Cash flows are considered less
important.
b. It provides a 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.
The most useful information to existing and
potential investors, lenders and other
creditors in predicting future cash flow is
a. Information about cash flows
b. Current earnings based on accrual
accounting
c. Information regarding the accounting
policies used by management
d. Information regarding the results obtained
by using a wide variety of accounting
policies
The accrual basis of accounting is most
useful for
a. Determining the amount of income tax
liability
b. Predicting the short-term financial
performance.
c. Predicting the long-term financial
performance.
d. Determining the amount of dividends to
be declared.
The primary focus of financial reporting has
been on meeting the needs of which of the
following groups?
a. Management
b. Existing and potential investors, lenders
and other creditors
c. National and local taxing authorities
d. Independent CPAs
Which of the following best describes the
term "financial position"?
a. The net income and expenses
b. The net of financial assets less liabilities
c. The potential to contribute to the flow of
cash and cash equivalents
d. The assets, liabilities and equity
The objectives of financial reporting are
based on
a. The need for conservatism
b. Reporting on management stewardship
c. Generally accepted accounting principles
d. The needs of the users of the information
Which of the following statements is not a
major objective of financial reporting?
a. It shall provide information about entity
resources, claims against those resources
and changes in them.
b. It shall provide information useful in
evaluating management stewardship.
c. It shall provide information useful in
investment, credit and similar decision.
d. It shall provide information useful in
assessing cash flow prospects.
Which of the following is not an objective of
financial reporting?
a. To provide information about an entity's
assets and claims against those assets
b. To provide information that is useful in
assessing an entity's sources and uses of
cash
c. To provide information that is useful in
lending and investing decisions
d. To provide information about the
liquidation value of an entity
The information provided by financial
reporting pertains to
a. Individual business entities, rather than to
industries or an economy as a whole or to
members of society as consumers
b. Business industries, rather than to
individual entities or an economy as a whole
or to members of society as consumers
c. Individual business entities, industries
and an economy as a whole, rather than to
members of society as consumers
d. An economy as a whole or to members of
society as consumers, rather than to
Individual business entities or industries
During a period when an entity is under the
direction of a particular management,
financial reporting will directly provide
information about
a. Both entity performance and
management performance
b. Management performance but not entity
performance
c. Entity performance but not management
performance
d. Neither entity performance nor
management performance
Which best describes the term "going
concern"?
a. Current liabilities exceed current assets.
b. Ability of the entity to continue in
operation for the foreseeable future
c. Potential to contribute to the flow of cash
and cash equivalents to the entity
What is an implication of the going concern
assumption?
a. The historical cost principle is credible.
b. Depreciation and amortization policies
are justifiable and appropriate.
c. The current and non-current classification
of assets and liabilities is justifiable and
significant.
d. All of these.
The relatively stable economic, political and
social environment supports
a. Conservatism
b. Materiality
c. Timeliness
d. Going concern
Which of the following is not a basic
assumption underlying financial accounting?
a. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Historical cost assumption
What is being violated if an entity provides
financial reports in connection with a new
product introduction?
a. Economic entity
b. Periodicity
c. Monetary unit
d. Continuity
Which underlying assumption serves as the
basis for preparing financial statements at
regular artificial points in time?
a. Accounting entity
b. Going concern
c. Periodicity
d. Stable monetary unit
Which basic accounting assumption is
threatened by the existence of severe
inflation in the economy?
a. Monetary unit
b. Periodicity
c. Going concern
d. Economic entity
Which basic assumption may not be
followed when an entity in bankruptcy
reports financial results?
a. Economic entity
b. Going concern
c. Periodicity
d. Monetary unit
Inflation is ignored in accounting due to
a. economic entity
b. going concern
c. monetary unit
d. time period
The economic entity assumption
a. Is applicable to unincorporated
businesses
b. Recognizes the legal aspects of business
organizations
c. Requires periodic income measurement
d. Is applicable to all forms of business
organizations
The concept of accounting entity is
applicable
a. Only to the legal aspect of business
organizations
b. Only to the economic aspects of business
organizations
c. Only to business organizations
d. Whenever accounting is involved
When a parent and subsidiary relationship
exists, consolidated financial statements are
prepared in recognition of
a. legal entity
b. economic entity
c. stable monetary unit
d. time period
The valuation of a promise to receive cash
in the future at present value is valid
because of what accounting concept?
a. entity
b. time period
c. going concern
d. monetary unit
What is the accounting concept that justifies
the usage of accruals and deferrals?
a. going concern
b. materiality
c. consistency
d. stable monetary unit
The parent entity in Manila has a subsidiary
in Japan. The financial statements of the
subsidiary are translated to pesos for
consolidation with financial statements of
the parent entity at year end.
Accounting entity
A machinery was imported from USA at a
certain cost five years ago. Because of
inflation, the machinery has now a current
replacement cost which is very much higher
than the historical cost. Management would
like to report the machinery at current
replacement cost.
Monetary unit
An entity has experience a drastic reduction
n revenue by reason of a long dry spell in
the area where the entity grows its tobacco.
The management decided to wait until next
year and present financial statements for a
two-year period rather than prepare now the
traditional 12-month financial statements.
Time period
During the lifetime of an entity, accountants
produce financial statements at arbitrary
points in time in accordance with what basic
accounting concept?
a. accrual
b. periodicity
c. unit of measure
d. continuity
A subsidiary was exhibiting poor financial
performance for the current year. In an effort
to increase the subsidiary's reported
income, the parent entity purchased goods
from the subsidiary at twice the normal
markup.
Accounting entity
The operations of a saving bank are being
evaluated by the BSP. During the
investigation, the BSP has determined that
numerous loans made by top management
were unwise and have seriously
endangered the future of the saving bank.
Going concern
An entity decided to publish fin statements
only in the years when it had good news to
report.
Time period
An entity reported inventory, PPE and
intangible assets at current value at
year-end.
Going concern
An electronics entity owned by a proprietor
reported the cost of the proprietor's
swimming pool as an asset of the entity.
Accounting entity
An entity prepared financial statements
adjusted for changes in purchasing power.
Monetary unit
A mining entity kept no accounting records
after starting business. The entity is waiting
until the mine is exhausted to determine the
success or failure of business.
Time period
An entity reported financial statements in
nominal pesos that have mixed rather than
uniform amount of purchasing power.
Monetary unit
A MNC published a complete set of financial
statements at least once a year, regardless
of whether the financial results were good or
bad.
Time period
The pesos of today can buy as much goods
and services as the pesos five years ago.
Monetary unit
An accounting entity is viewed as continuing
in operation in the absence of the evidence
of the contrary.
Going concern
An accounting practitioner mixed personal
accounting records with the records of the
accounting practice.
Accounting entity