INTRODUCTION TO FINANCIAL REPORTING Lesson 1
LEARNING OBJECTIVES
At the end of the lesson, students must be able to:
1. Determine the objective of financial reporting and the different users of financial Information.
2. Determine the purpose of financial statements.
3. Enumerate and explain the complete sets of financial statements
4. Identify and explain the elements of financial statements.
5. Explain the general features and concepts when preparing financial statements.
OBJECTIVE OF FINANCIAL REPORTING
According to the Conceptual Framework, the objective of general-purpose financial
reporting is:
"To provide financial Information about the reporting entity that is useful to
existing and potential investors, lenders, and other creditors in making decisions relating
to providing resources to the entity."
The decisions mentioned involve:
a. buying, selling, or holding equity and debt instruments;
b. providing or settling loans and other forms of credit; or
c. exercising rights to vote on, or otherwise influence, management's actions that affect
the use of the entity's economic resources.
General Principles related to general-purpose reporting
a. General-purpose financial reporting occurs since existing and potential users of
financial information cannot require reporting entities to provide Information directly to
them.
b. General-purpose financial reports do not and cannot provide all of the Information
that the users may need.
c. General-purpose financial reports are not designed to show the value of a reporting
entity, but they provide information to help existing and potential users to estimate the
value of the reporting entity.
d. To a large extent, financial reports are based on estimates, judgements, and models
rather than exact depictions.
Different Users of General-Purpose Financial Reports
For financial reporting purposes, users of general-purpose financial reports can be
classified as follows:
Users of General-Purpose Financial Reports
Primary Users
These are the users to whom generalpurpose financial reports are directed.
These include existing and potential
investors, lenders, and other creditors.
Other Users
These are the other users that may find
general-purpose financial reports useful.
These include, but are not limited to,
employees, suppliers, customers,
government, and researchers.
PURPOSE OF FINANCIAL STATEMENTS
1. Primary objective: To provide Information about the financial position, financial
performance, and cash flows of an entity that is useful to a wide range of users in
making economic decisions.
2. Secondary Objective: To show the results of management's stewardship over the
entity's resources entrusted to it.
To meet the objective, FS provide Information about an entity's:
a. assets
b. liabilities
c. equity
d. income and expenses, including gains and losses
e. contributions by and distributions to owners in their capacity as owners; and
f. cash flows
Complete Set of Financial Statements (PAS 1)
1. a Statement of financial position as at the end of the period;
2. a Statement of profit or loss and other comprehensive Income (OCI) for the period;
3. a Statement of changes in equity for the period;
4. a Statement of cash flows for the period;
5. notes to the financial statements;
6. comparative information in respect of the preceding period; and
7. when an entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statements, or when it reclassifies items in its
financial statements a third statement of financial position as at the beginning of the
preceding period shall be presented.
Each component of financial statements contains different financial information
relevant to the users of the financial statements:
COMPONENTS
INFORMATION PROVIDED
Statement of
financial position
Information regarding an entity's assets (le, resources it controls),
liabilities (Le., claims of third parties against these assets), and
equity (i.e., claims of owners against assets).
Statement of profit
or loss and OCI
Information regarding an entity's financial performance, which is
comprised of revenues, Income, expenses, gains, and losses during
the particular reporting period.
Information regarding the changes in an entity's equity during a
particular reporting period arising from financial performance and
transactions with owners such as additional contributions or
distributions.
Statement of
changes in equity
Statement of cash
flows
Shows the sources and uses of cash during a particular period,
which are classified as either operating, investing, or financing.
Notes to financial
statements
Shows significant accounting policies and other explanatory
Information, such as the breakdown and narrative description of
the amounts presented in other components of financial
statements.
Comparative
information in
respect of
preceding period
Not really a separate statement, but the information it provides are
already embedded in the other components of the financial
statements. This makes an easier comparison of financial
information for the current period against the same financial
information for the preceding period.
Lastly, due to this requirement, there will be two money columns
on each other components of financial statement.
ELEMENTS OF FINANCIAL STATEMENTS (ACCORDING TO CONCEPTUAL FRAMEWORK)
a. Asset- a present economic resource controlled by the entity as a result of past events
b. Liability - a present obligation of the entity to transfer an economic resource as a
result of past events
c. Equity - the residual interest in the assets after deducting all of its liabilities
d. Income - increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims
e. Expense - decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims.
GENERAL FEATURES AND PRINCIPLES IN PREPARING FINANCIAL STATEMENTS
a. Fair presentation and compliance with PFRSB
e. Offsetting
b. Going concern assumption
f. Frequency of reporting
c. Accrual basis of accounting
g. Comparative information
d. Materiality and aggregation
h. Consistency of presentation
FAIR PRESENTATION AND COMPLIANCE WITH PFRSS
1. Fair Presentation and Compliance with PFRSs - Financial statements shall present
fairly the financial position, financial performance, and cash flows of an entity. Fair
presentation requires the faithful representation of the effects of transactions, other
events and conditions in accordance with the definitions and recognition criteria for
assets, liabilities, income and expenses set out by the Conceptual Framework (PAS
1.15). There is a presumption that the application of PFRSs, including supplementary
disclosures, when necessary, will result financial statements that achieving a fair
presentation, In addition, if an entity complied with all (i.e., not just majority nor just a
certain portion) of the requirements of PFRSs, an explicit and unreserved statement of
such compliance shall be included in the notes.
GOING CONCERN ASSUMPTION
2. Going concern - An entity prepares financial statements using the going concem
assumption, which means that the entity expects that it will continue operating in the
foreseeable future. This assumption is the basis of all the measurement requirements as
discussed in previous in previous topics for each item of assets, liabilities, and equity.
The exception to this assumption is when the management intends to liquidate the
entity or to cease trading or has no realistic alternative but to do so. In these cases, the
financial statements shall use the "liquidating concern" assumption.
Consequently, an entity is required to assess whether the use of going concern
assumption is appropriate. The assessment shall take into account all available
information about the future, which shall be at least, but not limited to, twelve months
from the end of the reporting perlod.
ACCRUAL BASIS OF ACCOUNTING
3. Accrual Basis of Accounting - An entity shall prepare its financial statements, except
for cash flow information, using the accrual basis of accounting. "Income or revenues
are recognized when earned, regardless of their receipt and expenses are recognized
when incurred, regardless of their payment."
4. Materiality & Aggregation - Each material class of similar items must be presented
separately in the financial statements.
5. Offsetting - Assets and liabilities, and income and expenses, shall not be offset unless
required or permitted by a PFRS.
Measuring assets net of valuation allowances, for example, obsolescence
allowances on inventories, allowances for doubtful accounts on receivables, and
accumulated depreciation on property, plant, and equipment are not offsetting.
MATERIALITY AND AGGREGATION
4. Materiality & Aggregation
In aggregating information for financial statement purposes, an entity shall apply the
following principles:
a. An entity shall present separately each material class of similar items.
For example, machinery, land and building are all aggregated to a single amount
in the statement of financial position as property, plant and equipment (PPE) since
they are similar items and usually have material balances;
b. An entity shall present separately items of a dissimilar nature or function unless they
are Immaterial.
For example, receivables are not aggregated with PPE Items since they are not
similar with each other, and at the same time, their amounts are usually material.
c. If a line item is not individually material, It is aggregated with other items elther in
the financial statements or in the notes.
For example, prepaid insurance and office supplies are usually aggregated within a
single amount called "other assets" since their amounts are usually immaterial,
regardless of their dissimilar nature;
d. An item is not sufficiently material to warrant separate presentation in those
statements may warrant separate presentation in then notes.
Continuing with "other assets" example, the components of its balance are
presented in the notes to financial statements, which will, in turn, show the balances of
prepaid Insurance and office supplies.
Materiality
Information is material if omitting, misstating, or obscuring it could reasonably be
expected to influence decisions that the primary users of general-purpose financial
statements make on the basis of those financial statements. Materiality depends on the
nature or magnitude of information, or both. (PAS 1.7) The reference of materiality in
this case is the financial statements taken as a whole. Lastly, the assessment of
materiality uses judgment.
For example, by applying the "magnitude of information" element of materiality, a
dozen of canned goods is not material to a leading supermarket, however, this is
material for a sari-sari store. Thus, an item that is material in one entity, is not
necessarily material for another entity.
Another example, using the "nature," element of materiality, a cashier's theft of
money might be considered as material, regardless of the amount involve. The reason is
that this weakness in internal control might result to a larger amount of losses for the
entity If no actions are taken to correct it.
OFFSETTING
5. Offsetting
In general, an entity shall not offset its assets and liabilities, or income and
expenses, unless a particular accounting standard allows it. Consequently, assets shall
be presented separately from liabilities while income shall be presented separately with
expenses.
For example, an entity shall not deduct the amount of mortgage payable from the
related land that serves as the security for this liability. On the other hand, the
amount of sales and cost of goods sold shall also be presented separately, rather
than presenting the income statement with the gross profit as the starting point.
The reason for this prohibition is that offsetting will usually not show the full
picture of each transaction or balances, which might affect the decision-making and
insights of the users of the financial statements.
It should be noted that measuring assets net of valuation allowances is not considered
as offsetting, for example:
1. Deducting allowance for bad debts from gross accounts receivable to arrive at the
carrying amount of accounts receivable.
2. Deducting the accumulated depreciation from the cost of PPE Items to arrive at the
net carrying amount of PPE.
3. Deducting the unearned interest income from the face of noninterest-bearing notes
receivable at the net carrying amount of notes receivable.
In addition, the following are the exceptions to the offsetting prohibition:
1. If the offsetting reflects the substance of the transaction, for example:
a. Deducting selling expenses from the gain on sale of PPE items.
b. Deducting reimbursement amount from the amount of loss on provision.
2. If the gains or losses arise from a group of similar transactions, for example:
a. Foreign exchange gains or losses.
b. Unrealized gains and losses from FVTPL securities
c. Unrealized gains and losses from FVTOCI securities
FREQUENCY OF REPORTING
6. Frequency of reporting
An entity shall publish financial statements (including comparative information) at
least annually. For example, an entity cannot publish financial statements every two
years, and it cannot also present financial statements covering more than one year.
In practice, these annual financial statements cover any one of the following:
1. Calendar year-covers January 1 up to December 31 of each year
2. Fiscal year-covers one-year period other than the period covered by calendar year.
For example, a period from July 1, 2024 to June 30, 2025 is considered as fiscal year.
3.52-week year-based on the fact that one-year period spans roughly 52.14 weeks (365
days/7 days a week)
COMPARATIVE INFORMATION
7. Comparative Information
Generally, an entity shall present comparative information with respect to the
preceding period for all amounts reported in the current period's financial statements
(PAS 1.38). For example, during the prior period, an entity Included the amount of its
interest income to the total amount of its other income. However, during the current
year, the entity decided to separately present the amount of interest income since its
amount becomes material. In this case, the entity shall also separately present the
corresponding interest income amount in comparative information for the prior period,
even if it is immaterial during that period.
To facilitate this year-on-year comparison, an entity, as a minimum, shall also
present two of each financial statements and the related notes.
THIRD STATEMENT OF FINANCIAL POSITION
In addition to the two sets of statement of financial position as required by the
comparative information feature, a third statement of financial position shall be
presented by an entity under the following circumstances:
a. the entity applies accounting policy retrospectively;
b. the entity makes a retrospective restatement of items in its financial statements
(e.g., correction of errors)
c. the entity reclassifies items in its financial statements
In such cases, an entity shall present three statements of financial position as at:
a. the end of the current period;
b. the end of the preceding period;
c. The beginning of the preceding period (or the presented earliest comparative
period). This is the date of the third statement of financial position.
Consequently, there will be three money columns in the statement of financial
position. However, the notes to the financial statements are not required to describe all
the amounts in the third statement of financial position.
For example, if an entity presents statement of financial position for the year 2023, the
three money columns shall be dated as follows:
a. December 31, 2023-end of the current period
b. December 31, 2022-end of the preceding period
c. January 1, 2022-beginning of the preceding period (the third balance sheet)
Additional Comparative Information for Listed Entities
Listed entities in the PSE are required to prepare the following statements covering
three years (l.e., one additional comparative period covering the period before the
immediately preceding period):
a. Statement of comprehensive income
b. Statement of changes in equity
c. Statement of cash flows
d. The related notes for these financial statements
CONSISTENCY OF PRESENTATION
8. Consistency of presentation
Consistency is the key for comparability. Consequently, an entity shall retain the
presentation and classification of items in the financial statements from one period to
the next, unless:
a. the change in presentation or classification would be more appropriate; or
b. another standard requires a change in presentation.
Structure and content of FS
The following information shall be displayed prominently and repeatedly whenever
relevant to the understanding of the Information presented:
a. The name of the reporting entity;
b. Whether the statements are for the Individual entity or for a group of entities;
c. The date of the end of the reporting period or the period covered by the
financial statements;
d. The presentation currency; and
e. The level of rounding used in presenting the amounts in the financial
statements (e.g. thousands, millions, etc.)