REPORT ON ACCOUNTING POLICIES
BY: THELMA SANTOS and LUCY MONTELLANO
30 August 2014
Foreword
The topic “Accounting Policies” was identified as #15 in the list of the Residencia Auditor’s
Membership belief it needs to revisit and review, as part of its 2014 “bayanihan education
program”, and as it pertains to the service and manufacturing industry.
Thelma will try to take on the service side while Lucy chose to take up the manufacturing side;
highlighting the accounting policies as required to conform with current PFRS for SME
standards.
In today's accounting policies and systems, the methods of calculation are more complex, but
the need for accuracy still applies.
For this exercise, there is a need to revisit the groundwork of broad information on accounting
policies and its re-emergence to the present call of compliance from GAAP to PFRS for SME as it
pertains to the service industry.
The bottom-line is to further enhance an auditor skills to match the globalization standards
facing the accounting industry as a whole.
BACKGROUND
What is Accounting?
Accounting is the skill, system, or job of keeping the financial records of a business or person.
How is accounting initiated?
Accounting begins with a transaction which is a business event that has a monetary impact on a
company’s (or individual’s) financial statements, and is recorded as an entry in
its accounting records.
Then it goes through a systematic development and analysis of information about the economic
affairs of an organization (be it corporate or individual).
The actual recording and summarizing of financial transactions is known as bookkeeping.
When the data thus produced are abstracted in reports (usually monthly, quarterly or annually)
for the use of persons outside the organization, the process is called financial accounting.
Reports Generated
Three reports are typically generated in financial accounting:
1. The balance sheet (now referred to as Statement of Financial Position), which
summarizes the firm's assets and liabilities;
2. the income statement (now referred to as either Statement of Income or Statement
of Comprehensive Income), which reports the firm's gross proceeds, expenses, and
profit or loss;
3. and the Statement of Cash Flow, which analyzes the flow of cash into and out of the
firm.
Uses of Accounting/Financial Reports
The creation of reports (usually monthly, quarterly and annually) for internal planning and
decision-making is called managerial accounting.
1. Its aim is to provide managers with reliable information on the costs of operations
and on standards with which those costs can be compared, to assist them in
budgeting and sales forecasting.
2. Investors, public and private, outside of the organization, rely and use the
accounting/financial reports to evaluate in relation to their business needs.
3. On these basic reports are the basis for BIR reportorial compliance and its
presentation crucial to SEC required presentation of accounts;
4. Likewise, these basic reports, becomes an auditor’s mine field to make certain that
such transaction recordings is within the bounds of an organization’s accounting
policies and procedures as well as in conformity with the latest pronouncements of
IFRS (International Financial Reporting Standards) of which the Philippines is a
signatory of more than 100 countries, whose focus is to be able to achieve common
standards easily understandable by public and private users of the said basic reports.
Basic Accounting Policies
Basic accounting policies indicate to bookkeepers how to record transactions. Also called
accountant trainees, help firms report accurate financial statements. Understanding basic
accounting policies, can help an accountant trainee/bookkeeper become financially savvy.
Financial managers rely on accounting entries to prepare operating and economic data
summaries.
Assets
Accounting norms dictate the way an accountant trainee/bookkeeper must record
asset-related transactions. These standards include Generally Accepted Accounting
Principles (GAAP) before and International Financial Reporting Standards (IFRS), the
current flavor.
Under IFRS and GAAP, an accountant trainee/bookkeeper debits an asset account to
increase its balance and credits the account to reduce its value.
Expenses
Expenses are charges that a company incurs through its operating activities. Journal
entries for expense recording are the same/similar as asset entries.
The accountant trainee/bookkeeper debits the account to increase it and credits it to
reduce the account's amount.
Liabilities
Debt accounting policies are important to determine a borrower's true indebtedness.
Liabilities are short-term debts -- those maturing within one year -- and long-term loans,
such as mortgages, accounts payable and bonds payable.
An accountant trainee/bookkeeper debits a liability account to reduce its value and
credits the account to increase its balance.
Equity
Equity items relate to investments that shareholders make in a company. Accurate
equity entries enable management to have a true sense of who owns the firm.
A accountant trainee/bookkeeper, would debit an equity account to decrease its
amount and credit it to increase the account balance.
Revenues
Sound record-keeping practices allow a business to know exactly how much money it
makes. A firm may generate revenues by selling merchandise, providing services or
both.
The accountant trainee/bookkeeper debits or credits a revenue account to decrease or
increase its value, respectively.
Petty Cash
Petty cash is considered a short-term asset, money that an organization sets aside to
pay for incidental expenses. These are small charges for which it does not make sense to
pay with checks as it may cost more to write, sign and send them.
An accountant trainee/bookkeeper debits the petty cash account to increase its amount
and credits the account to reduce its balance.
The accounting concept of debit is distinct from the banking terminology.
Debiting petty cash, an asset account, means increasing company’s funds.
Balance Sheet
Under GAAP before and currently under IFRS, accountants must follow specific rules
when preparing and publishing reams of company’s financial data.
A balance sheet is also called a statement of financial position or statement of financial
condition. This report must show in one account heading the short/long-term assets and
in another account heading the short/long-term liabilities of the company.
Income Statement
Financial managers often refer to this accounting report as a "statement of profit and
loss," "statement of income" or "P&L".
An income statement shows an organization's revenues, expenses and net profit. The
statement indicates net loss if revenues dwarf expenses.
Cash Flow Statement
Accounting policies for cash flow management and reporting help companies track
liquidity levels. Cash monitoring enables a business to determine whether it can afford
an operating goal.
A cash flow statement indicates specific items. These include cash flows from operating
activities, cash flows from investing activities and cash flows from financing activities.
List of Accounting Policies
Accounting policies represent internal business standards that employees follow when recording
financial transactions. Business owners and directors use accounting to record, report and
analyze financial transactions.
While financial transactions must be recorded according to generally accepted accounting
principles (GAAP before and currently under IFRS) , business owners do have some latitude when
developing accounting policies.
Depreciation
Depreciation is a monthly expense relating to business assets. Companies purchase
facilities and equipment to produce goods or services.
Rather than expense out these items at one time, GAAP before and currently with IFRS,
allows companies to record the purchase as an asset, and depreciate the item over
time.
Business owners can use several different depreciation methods for their accounting
policy. Straight line, declining balance and activity depreciation are a few commonly
used methods.
Depreciation methods depend on the type of asset, salvage value and expected useful
life of the company.
Inventory
Inventory valuation is another important accounting policy. Commonly used valuation
methods include first-in, first-out (FIFO); last-in, first-out (LIFO); and weighted average.
FIFO requires companies to sell the oldest inventory first. This method ensures the
company has the newest inventory and most accurate information in the company's
accounting ledger.
LIFO, the opposite of FIFO, is where companies sell the newest inventory first, leaving
the older inventory in the ledger. LIFO is not supported currently in IFRS.
The weighted average method simply recalculates a new cost for inventory items. This
method does not require companies to maintain a record of which inventory sells first.
Weighted average is currently no longer supported in IFRS.
Business owners set accounting policies for inventory because this information directly
impact the company's tax liability at year end.
Consolidation of Accounts
Larger businesses use accounting policies to consolidate financial accounts. Business
organizations maintaining ownership stakes in other companies may need to
consolidate financial accounts.
Consolidating financial accounts creates one set of financial information for the parent
and subsidiary companies.
Asset, liability, revenue, costs of goods sold, and retained earnings are a few financial
accounts that may require consolidation per accounting policies.
Research and Development
Research and development costs usually require accounting policies.
Development costs can carry forward on a company's accounting ledger, which creates
a capitalized expense.
Companies may not recognize capitalized research and development expenses until the
new product, facilities or equipment goes into use in the business operations.
However, companies usually expense out basic research and development costs as they
occur, as it indirectly affect the research and development costs.
Business owners set accounting policies to determine which research and development
items can carry forward and which are written off.
Types of Accounting Policies
Accounting policies are the backbone of a company’s financial accounting and reporting
processes. Senior company management ensure these policies conform to industry standards,
including generally accepted accounting principles, in consonance with international financial
reporting standards, or IFRS.
Company accountants also abide by the Bureau of Internal Revenue (BIR) and the Securities
and Exchange Commission (SEC) rules, regulations, etc., when preparing financial reports.
Revenue and Expense Recognition
A company records, or recognizes, revenue and expense items at market values, in
accordance with GAAP before and currently in consonance with IFRS.
Revenue is income that a company generates by selling goods and providing services.
Revenue items include sales, interest income, short-term profits and long-term gains on
investments.
An expense is a cost or loss that a firm incurs when selling goods or providing services.
Examples of expense items include salaries, utilities and cost of goods sold. A corporate
accountant debits an expense account to increase its amount and credits it to reduce
the account balance.
The opposite is true for a revenue account. A firm lists revenue and expense accounts in
its statement of profit and loss (P& L) at the end of a period, such as a month or quarter
or annual.
Asset and Liability Recording
Accounting rules and regulatory guidelines require a company to record assets and
liabilities at fair market amounts.
An asset is an economic resource that a company owns, and it can be a short-term or
long-term resource.
A short-term, or current, asset is a resource that a firm can convert into cash within 12
months.
Examples of short-term assets are cash, inventories and accounts receivable. A longterm fixed asset is a resource that a company can use for more than a year.
Fixed assets may be land, property, a plant, equipment and machines.
A liability is a debt that an organization must repay at a given point in time or over
specified installments.
A borrower must repay a short-term loan within a year and a long-term debt after a
year or more.
An accountant trainee/bookkeeper debits an asset account to increase its amount and
credits it to reduce the account balance. The opposite is true for a liability account.
A company lists asset and liability accounts in the balance sheet.
Financial Reporting
A company reports periodic financial statements that are complete, "fair" and conform
to GAAP before, currently IFRS, BIR, and SEC rules, regulations, and pronouncements.
In accounting or finance parlance, "fair" means accurate or objective.
Complete financial reports include a balance sheet (also referred to as statement of
financial position), statement of income (P& L), statement of cash flows and statement
of retained earnings (otherwise known as statement of equity).
Fixed Asset Accounting Policy
A company needs to value assets and liabilities accurately and completely at a given
point in time or at the end of each year or quarter. Fixed-asset accounting policies help
management value corporate resources properly.
Fixed Asset
A fixed asset is an economic resource that a firm owns and intends to use for
more than a year. Fixed asset is also known as a long-term asset. Examples
include land, buildings, plants, equipment and machinery.
Significance
Fixed assets represent large portions of corporate balance sheets. A business
partner, such as a lender, customer or supplier, often gauges a company's
economic robustness by reviewing corporate fixed assets. A firm may also use
fixed assets as collateral, or a financial guarantee, in a loan transaction.
Accounting for Asset Purchase
Accounting rules require a firm to record an asset purchase at fair or market
value. To record an asset addition, a fixed asset accountant debits the property,
plant and equipment account and credits the vendor payable account.
Accounting for Depreciation
In accounting parlance, depreciating a fixed asset means spreading its cost over
many years. To record an asset's depreciation, a fixed asset accountant debits
the depreciation expense account and credits the accumulated depreciation
account.
Accounting for Asset Sale
Accounting standards and regulations require a firm to record the sale of an
asset at market value. To record the disposition of an asset, a fixed asset
accountant debits the customer receivable account and credits the property,
plant and equipment account.
GAAP - Generally Accepted Accounting Principles
Before IFRS / PFRS for SME, GAAP was there.
There is a need to know what GAAP accounting policies were, to be able to appreciate
IFRS/PFRS for SME, as it pertains to the service industry.
GAAP is a principles-based framework, rather than rules-based, which requires business owners
to use accounting policies when recording certain financial transactions.
GAAP refers to a set of official standards and procedures that companies are required to use in
preparing their financial statements. GAAP dictates how companies records and reports their
financial data and are used to insure consistency and accuracy in accounting practices.
FASP (Financial Accounting Standard Board) is the source of most GAAP rules. GAAP principles
are suppose to give investors confidence in the accuracy of the company’s financial statements
and helps investors to accurately compare a company’s financial statement to another
especially if they are of the same industry.
Examples of GAAP rules still being used:
Includes how quarterly statements is prepared in the same manner as the annual
financials; and how current assets should include cash, marketable securities, accounts
and notes receivables, inventories, unearned income and prepaid expenses.
However, despite GAAP’s good intentions, companies are often times have varying
degree of discretion to use in assets appreciation and recognizing costs and revenues.
These leave room for companies to purge or manipulate the numbers; so users of
financial statements, especially investors need to examine financial statements carefully
to include the science of manipulating data.
The users should read the summary of significant accounting policies and all the
footnotes that contains key information to supplement the figures on a company’s
GAAP based financial statements.
Alas, the last paragraph, for most public accounting practitioners, have not place importance on
the footnotes of their GAAP financial numbers. Most often, no footnotes are done (until
IFRS/PFRS for SME came about). It leaves the users to exert more effort to understand the
financial statements of an organization.
But, it does appear that there are lots of similarities in the principles of Revenue Recognition
under IFRS and the GAAP, often resulting in the same accounting treatment.
Other future improvements will bring about changes in the standards for both the IFRS and
GAAP, which will result in facilitating the comparison of financial statements among investors
and other interested parties, such as advisors, investors, acquirers, etc., on how businesses will
come together.
IFRS – International Financial Reporting Standard
IFRS is considered a gift to global investors - the ability, for the first time ever, to make "applesto-apples" comparisons of financial numbers produced by individual companies or corporations,
no matter where they are headquartered.
That's what the International Financial Reporting Standards (IFRS) aim to accomplish.
IFRS are the accounting standards set by the International Accounting Standards Board (IASB),
which an entity can comply with if it wishes to create financial statements that are accepted in
those countries allowing the use of IFRS.
International Financial Reporting Standards were previously known as International Accounting
Standards (IAS).
As of July 2008, for the first time since 1973 when the London-based International
Accounting Standards Committee (IASC), now known as, the International Accounting
Standards Board (IASB) was established, the standards will be a global reality.
These standards will be recognized globally and will be set for organizations large (using
full IFRS/PFRS standards) and small (using IFRS/PFRS for SME standards).
Before IFRS, true transparency in numbers among companies worldwide simply did not
exist, or was deemed possible. As a result, cross-border investments were curtailed, as
was the growth of the overall global economy, particularly in emergingmarket countries.
In the past, investors generally chose to put their money in companies and countries
where they would be most comfortable with truthfulness in accounting practices and
systems and the sign-off of accounting firms standing behind those numbers. With the
implementation of IFRS, this is set to change.
SO . . What is IFRS?
IFRS refers to a set of international accounting standards stating how particular types of
transactions and other events should be reported in financial statements.
IFRS are issued by the International Accounting Standards Board.
IFRS are sometimes confused with International Accounting Standards (IAS), which are
the older standards that IFRS replaced. (IAS were issued from 1973 to 2000.)
The goal with IFRS is to make international comparisons as easy as possible. This is
difficult because, to a large extent, each country has its own set of rules.
For example, U.S. GAAP are different from Canadian GAAP and our very own Philippine
GAAP.
Synchronizing accounting standards across the globe is an ongoing process in the
international accounting community.
The Philippines equivalent of IFRS is known as Philippine Financial Reporting Standard (PFRS).
PFRS has adopted in toto IFRS and IFRS for SME standards.
PFRS – Philippine Financial Reporting Standard.
In the SEC Commission En Banc meeting dated December 3, 2009, it decided to adopt the
Philippine Financial Reporting Standards for Small and Medium-sized Entities (PFRS for SMEs).
The PFRS for SMEs were adopted by the Philippine Financial Reporting Standards Council (FRSC)
from the IFRS for SMEs issued by International Accounting Standards Board (IASB).
Who are qualified to apply PFRS for SMEs?
In the Philippines, the PFRS for SMEs shall be used by entities that meet the definition of
an SME as set forth in the SEC En Banc Resolution dated 13 August 2009. The SEC
defines an SME for financial reporting purposes as an entity:
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With total assets of between P3 million and P350 million or total liabilities of
between P3 million and P250 million;
That is not required to file financial statements under SRC Rule 68.1;
That is not in the process of filing its financial statements for the purpose of
issuing any class of instruments in a public market;
That is not a holder of a secondary license issued by a regulatory agency, such as
a bank (all types of banks), an investment house, a finance company, an
insurance company, a securities broker/dealer, a mutual fund and a pre-need
company; and
That is not a public utility.
The amount of total assets and total liabilities in (a) above shall be based on the audited
financial statements as of December 31, 2009.
When is the effectivity date?.
The PFRS for SMEs is effective for annual periods beginning on or after January 1, 2010.
However, the guidance for applying the requirements of Section 23, Revenue, in
recognizing revenue from agreements for the construction of real estate set forth in
paragraphs 23A.14 and 23A.15 shall apply for annual periods beginning on or after
January 1, 2012. The standard does not include a provision for early adoption.
Are there exemptions to PFRS for SMEs?
Yes, the SEC has approved nine (9) exemption from the mandatory adoption of the
Philippine Financial Reporting Standard for Small and Medium-sized Entities (PFRS for
SMEs) SMEs that meet any of the criteria set forth by SEC. An SME that avails of the
exemption must disclose in the notes to its financial statements the facts that support
its adoption of full PFRS instead of the PFRS for SMEs.
ACCOUNTING POLICIES – Service industry – PFRS for SME
Service Sector
The service sector or the service industry is referred to as the tertiary sector of the economy . It
is one of the three economic sectors, the others being the secondary sector(approximately the
same as manufacturing) and the primary sector (agriculture, fishing, and extraction such
as mining).
The tertiary sector of industry involves the provision of services to other businesses as well as
final consumers.
Services may involve the transport, distribution and sale of goods from producer to a consumer,
as may happen in wholesaling and retailing,
Or may involve the provision of a service, such as in pest control or entertainment,
The goods may be transformed in the process of providing the service, as happens in
the restaurant industry.
However, the focus is on people interacting with people and serving the customer rather than
transforming physical goods. Individuals employed in this sector produce services rather than
products.
For the last 100 years, there has been a substantial shift from the primary and secondary
sectors to the tertiary sector in industrialized countries. This shift is called tertiarisation. The
tertiary sector is now the largest sector of the economy in the Western world, and is also the
fastest-growing sector in developing countries. Many of them are in the professional category.
Issues for service providers
Service providers face obstacles selling services that goods-sellers rarely face. Services are not
tangible, making it difficult for potential customers to understand what they will receive and
what value it will hold for them. Indeed some, such as auditors, consultants, and providers of
investment services, offer no guarantees of the value for price paid.
Since the quality of most services depends largely on the quality of the individuals providing the
services, it is true that "people costs" are a high component of service costs. Whereas a
manufacturer may use technology, simplification, and other techniques to lower the cost of
goods sold, the service provider often faces an unrelenting pattern of increasing costs.
Differentiation is often difficult. For example, how does one choose one investment adviser
over another, since they often seem to provide identical services? Charging a premium for
services is usually an option only for the most established firms, who charge extra based upon
brand recognition.
Global importance of the Service Industry
The services sector plays an increasingly important role in the global economy and the growth
and development of countries.
Many productive systems, such as hospitals, beauty salons, consulting companies, banks and
airlines do not produce a tangible product that can be stored for later consumption.
Instead, the output of such systems is a service – for example, health care, good looks, advice,
loans, and transportation – that is consumed in the process of its production.
From our day-to-day experience, we know that the cost and quality of services provided even
within the same industry can vary a great deal.
We have preferences and are willing to pay for different components of service, such as speed,
quality, degree of variety, and so on. Better management of the system that provides the
service, consistent with customer preferences and requirements, will lead to greater
profitability for the firm.
We must therefore understand the nature of the various types of service systems and the
associated management tasks that are required to improve a service firm’s competitiveness.
In addition to the continuing growth of the service sector, the role of services in the
manufacturing sector has been increasing. With increasing automation and the use of
computers in the design of a product and its manufacturing process, technical and professional
staffs will have a greater role in the actual production of the product than will unskilled
workers. Thus, in the factory of the future the productive process may be guided by design
engineers, computer operators, and production planners.
Finally, service is part of the product. When we buy a consumer durable, such as an automobile,
a washing machine, or a solar heating system, a guarantee to service the product accompanies
the product itself. Often our decision to buy a product is influenced by the services provided
with the product.
Sample Format Accounting Policies and Procedures - Services
The enclosed Accounting Policies and Procedures is for a start up business company for
the Service Industry.
It can be expanded depending on the specific and precise needs of the clientele, be it
individual or company.
SAMPLE : Notes to Financial Statements - PFRS for SME – Services
Except for the name of the company (not authorized to use in classroom activities) and
other information are left blank, the numbers are actual for filing on 15 August 2014,
(fiscal year ending 30 June 2014).
The requirements as listed below needs individual accounting policy on each account as
appropriate to a service company using PFRS for SME.
Any comments will be highly appreciated and will adopt them for fiscal year 2015.
Basic Requirements for Disclosure on Notes to FS:
ASSETS:
1. Initial Recognition & Measurement
2. Balance Sheet Valuation (Subsequent Measurement)
3. De-recognition
4. Impairment
LIABILITIES:
1. Initial Recognition & Measurement
2. Balance Sheet Valuation (Subsequent Measurement)
3. De-recognition
FINANCIAL INSTRUMENTS
ASSETS:
1. Cash & Cash Equivalent
2. Trade & Other Receivables
3. Non- Current Asset :
3.1 Refundable Deposits
LIABILITIES:
1. Trade & Other Payables
2. Loans Payable - Current
3. Non-Current Liabilities :
3.1 Advances from Stockholder
3.2 Loans Payable