Topic 3 and 4

Financial Statements

are formal reports of the economic activities and positions of an enterprise, organization, person, or other entities.

Shareholders

they use the financial statements to evaluate the risk and return of their company investments and make investment decisions based on their analysis.

Prospective investors

use the financial statements to assess the viability of investing in a company.

Management

uses financial statements to communicate the company’s past performance and future expectations.

IAS 1

presents the basis for the presentation of financial statements.

Statement of Financial Position

is a summary of an entity’s economic resources, economic obligations, and equity of their relationships to each other at the end of the reporting period.

Asset

a present economic resource controlled by an entity as a result of past events.

Economic resource

is a right that has the potential to produce economic benefits.

Liability

is a present obligation of an entity to transfer an economic resource as a result of past events.

• It is an obligation of an entity

• The obligation is to transfer an economic resource.

• The present obligation arises from a past event.

Essential characteristics of a liability

Equity

the residual interest in the entity’s assets after deducting all liabilities.

Substance over form

attention must be given to its underlying substance and economic reality and not merely in legal form.

Current Assets

• It expects to realize the asset, or intends to sell or consume it, in its normal operating cycle

• It holds the asset primarily for trading

• It expects to realize the asset within twelve months after the reporting period.

• The asset is cash or a cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.

Examples of Current assets

• Cash and cash equivalents

• Trade and other receivables

• Financial asset at Fair Value through Profit of Loss

• Inventories 

• Prepaid expenses

Normal operating cycle

the time between the acquisition of assets for processing and their realization in cash or cash equivalents.

Property, Plant, and Equipment

include all intangible assets with an estimated useful life beyond one year that are held for rental to others, for production of goods and services, or administrative purposes.

Investment Property

is land or a building held to earn rentals or for capital appreciation, or both, rather than for use in the production or supply of goods or services or administrative purposes, or sale in the ordinary course of business.

Investment in Associates

refers to an investment in equity securities of another enterprise that provides the investor significant influence over the investee.

Deferred Tax Asset

an account resulting from a temporary difference between the book and tax bases of certain assets and liabilities.

Intangible Assets

are identifiable non-monetary assets without physical substance, controlled by the enterprise, and provide the enterprise with some rights, privileges, and competitive advantages.

Biological Assets

are living animals and plants held by a company engaged in raising livestock, forestry, cropping, cultivating orchards and plantation, floriculture, or aquaculture.

Current Liabilities

• The entity expects to settle it in the entity’s normal operating cycle

• The entity holds the liability primarily for trading purposes

• It is due to be settled within twelve months after the reporting period

• The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting period.

Current liabilities include 

• Trade and other payables

• Current provisions

• Short-term borrowings

• Current portion of long-term debt

• Current tax liability

An entity shall exercise its judgment on whether to present additional items separately based on its assessments of

• The nature and liquidity of assets

• The function of assets within the entity

• The amounts, nature, and timing of liabilities.

Report Form

assets, liabilities, and equity are vertically shown in that order.

Account Form

this form follows the T-account format where assets are shown on the left side while liabilities and equity are shown on the right side of the statement of the financial position.

Financial Position Form

this form emphasizes the working capital position of an enterprise.  In this format, net assets are equal to the equity.

IAS 10

events after the reporting period.

Events after the reporting period

an entity should assess the events that may have taken place after the reporting period, particularly between the end opf the reporting period and the date when financial statements are authorized for issue.

Adjusting Events

an event after the reporting date that provides further evidence of conditions that existed at the reporting date.

Examples of adjusting events

• Events that indicate that the going concern assumption in relation to the whole or part of the entity is not appropriate

• Settlement after reporting date of court cases that confirm the entity had a present obligation at reporting date

• Bankruptcy of a customer that occurs after reporting date that confirms a loss existed at reporting date on trade receivables

• Sales of inventories after reporting date that give evidence about their net realizable value at reporting date

• Determination after reporting date of cost of assets purchased or proceeds from assets sold, before reporting date

• Discovery of fraud or errors that show the financial statements are incorrect.

Non-adjusting Event

an event after the reporting date that is indicative of a condition that arose after the reporting date.

Examples of non-adjusting events

• Major business combinations or disposal of a subsidiary

• Major purchase or disposal of assets, classification of assets as held for sale or expropriation of major assets by government

• Destruction of a major production plant by fire after reporting date

• Announcing a plan to discontinue operations

• Announcing a major restructuring after reporting date

• Major ordinary share transactions

• Abnormal large changes after the reporting period in assets prices or foreign exchange rates

• Changes in tax rates or tax law

• Entering into major commitments such as guarantees

• Commencing major litigation arising solely out of events that occurred after the reporting period.

Notes to the Financial Statements

these include information about the nature of the entity, basis for presentation of the financial statements and significant accounting policies, details on the line items presented on the face, additional information required by the PFRS/IFRS that are not shown on the face, and basis for estimates and judgments and settling uncertainties.

Operating Cycle

the time between the acquisition of materials and its realization in cash or an instrument readily convertible into cash.

Philippine Financial Reporting Standards

set out the recognition, measurement, presentation, and disclosure requirements of financial statements.

Refinancing

is an arrangement between a debtor and a creditor to defer the settlement of an obligation by extending the maturity date or issuing a debt instrument to settle the maturing debt.

Working Capital

excess of current assets over current liabilities.

Accounting Policies

these are specific in principles, bases, conventions, rules, and practices an entity applies in preparing and presenting financial statements.

Accrual Basis

the basis of accounting where income is recognized when earned, not necessarily when cash is received, and expenses are recognized when incurred, not when cash is paid.

Cash

an item accepted for deposit at face value by bank or other financial institutions.

Cash Equivalents

highly liquid financial instruments that are so near their maturity that there is an insignificant risk of change in value due to changes in interest rate.

Going Concern

assumes that in the absence of evidence to the contrary, an enterprise will continue operations in the future.

Statement of Comprehensive Income

presents information on the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners.

Two approaches in determining profit

• Capital Maintenance Approach

• Transaction Approach

Capital Maintenance Approach

measures profit or net income as excess of ending capital over the beginning capital after excluding the effects of transactions with owners.

Financial Capital Maintenance Concept

earns profit only if the financial amount of the net assets at the end of the period exceeds the financial amount of the net assets at the beginning of the period, after excluding distributions to, and from, owners during the period.

Physical Capital Maintenance Concept

requires the adoption of the current cost basis of measurement. Under this concept, an enterprise earns a profit if the physical productive capacity at the end of the period exceeds the physical productive capacity at the beginning after excluding distributions to and from the owners.

Transaction Approach

profit is the difference between the total income and total expenses for a given reporting period, based on recorded transactions of the enterprise.

Profit or Loss

is the total income less expenses excluding the components of other comprehensive income

Elements of Performance

• Income 

• Expenses

Income

increases in economic benefits during the reporting period in the form of inflows enhancement of assets or decreases of liabilities that results in increase in equity other than those relating to contributions from equity participants.

Revenue

arise from central or major revenue-producing activities.

Gains

arise from incidental transactions to the entity’s operation.

Expenses

decreases in economic benefits during the reporting period in the form of outflows or depletion of assets or incurrences of liabilities that result in decreases in equity other than those relating to distributions to equity participants.

Presentation of Comprehensive Income

• Single statement

• Two-statement format

Single statement

with profit or loss and other comprehensive income presented in two sections

Two-statements

a separate statement of profit or loss and a separate statement of other comprehensive income.

Entity’s consolidated financial statements shall disclose allocations for the period

• Profit or loss attributable to

  • Non-controlling interests

  • Owners of the parent

• Total comprehensive income attributable to

  • Non-controlling interests

  • Owners of the parent

Extraordinary Items

an entity shall not present any items of income or expenses as extraordinary items.

Nature of Expense Method

shows expenses and purchases, salaries and wages, depreciation, utilities, and other operating expenses.

Function of Expense Method

expenses are classified according to their function in the enterprise operation.

Finance Cost

should be presented as a separate line item in the profit or loss, regardless of the method of presenting expenses in the statement of comprehensive income.

Management

they are required to select the information that is reliable and more relevant.

Discontinued Operation

is a component of an entity that either has been disposed of, or is classified as held for sale, and:

• Represents a separate major line of business or geographical area of operations

• Is a part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations

• Is a subsidiary acquired exclusively with a view of sale.

Component of Entity

comprises operations and cash flows that can be distinguished operationally and for financial reporting purposes from the rest of the entity.

An entity shall disclose a single amount in the statement of comprehensive income comprising the total of:

1. the post-tax profit or loss of discontinued operations

2. the post-tax gain or loss recognized on the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operation.

Statement of Changes in Equity

shows the events and transitions that took place during a reporting period that affected equity.

Statement of changes in equity includes the following

• Total comprehensive income for the period, showing separately the total amounts attributable to owners of the parent to non-controlling interests.

• For each component of equity, the effects of retrospective application or retrospective restatement recognize in accordance with IAS 8

• For each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes from profit or loss, other comprehensive income, and transactions with owners in their capacity as owners.

IAS 8

requires retrospective adjustments to effect changes in accounting policies, to the extent practicable, except when the transition provisions in another IFRS require otherwise.

Notes

provide narrative descriptions or disaggregations of items presented in those statements and information about items that do not qualify for recognition in those statements.

Systematic Manner

the entity shall present notes in this manner while considering the effect on the understandability and comparability of its financial statements

Purpose of notes

• Present information about the basis of preparation of the financial statements and the specific accounting policies used

• Disclose the information required by IFRSs that is not presented elsewhere in the financial statements

• Provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them.

Compliance with IFRS

an entity shall make an explicit and unreserved statement of such compliance in the notes.

An entity shall disclose its significant accounting policies comprising

• Measurement basis (bases)

• The other accounting policies used that are relevant to an understanding of the financial statements

Measurement bases include

• Historical cost

• Current cost

• Realizable value

• Fair value

• Present value

• Recoverable amount

Disclosure of sources of estimation uncertainty

an entity shall disclose information about the assumptions it makes about the future, and other major sources of estimation uncertainty at the end of the period.

Disclosure of managing capital

an entity shall disclose information that enables users of its financial statements to evaluate the entity’s objectives, policies, and processes for managing capital.

Earnings per share

amount of earnings for a period attributable to each ordinary share.

Distribution cost

expenses related directly to the company’s efforts to generate sales.

Cost of Goods Sold

cost of the inventory items sold during the period.

Statement of Cash Flow

provides information about an entity’s cash receipts and cash disbursements during a reporting period.

IAS 7 par. 7

provides that an investment normally qualifies as a cash equivalent only when it has a short maturity of three months or less from date of acquisition.

Cash flows

are inflows and outflows of cash and cash equivalents.

Operating Activities

are the principal revenue-producing activities of the entity and other activities.

Investing Activities

are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

• Working Capital

• Other not related to investing and financing

Operating Activities

• Non-current assets

• Investments except trading

Investing Activities

Financing Activities

are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.

• Equity items

• Borrowings

Financing Activities

Compensating balance

is an amount that a borrower must contain in a bank.

Direct Method

whereby major classes of gross cash receipts and gross cash payments are disclosed

Indirect Method

whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows.

IAS 7

explicitly encourages entities to report cash flows from operating activities using the direct method.

Creditors and Suppliers

need financial statements to make informed decisions on providing credit to entities.