Unit 1: Financial Reporting

Intended Learning Outcomes

After reading this unit, you should be able to:
 describe the purpose of accounting and financial reporting;
 identify the need for information of the users of accounting information;
 describe the branches of accounting;
 discuss the development of accounting standards and financial reporting standards;
 identify the organizations involved in the promulgation of the accounting standards;
 describe the due process of developing international financial reporting standards; and
 describe the due process of developing and promulgating Philippine Financial Reporting
Standards.

The Purpose of Accounting and Financial Reporting

The purpose of accounting is to accumulate and report on financial information about the
performance, financial position, and cash flows of a business. This information is then used
to reach decisions about how to manage the business, or invest in it, or lend money to it.
This information is accumulated in accounting records with accounting transactions, which are
recorded either through such standardized business transactions as customer invoicing or
supplier invoices, or through more specialized transactions, known as journal entries.

Once this financial information has been stored in the accounting records, it is usually
compiled into financial statements, which include the following documents:

 Statement of Comprehensive Income

 Statement of Financial Position

 Statement of Cash Flows

 Statement of Changes in Equity

 Notes to the Financial Statements

The accountant may generate additional reports for special purposes, such as determining the
profit on sale of a product, or the revenues generated from a particular sales region. These
are usually considered to be managerial reports, rather than the financial reports issued to
outsiders.

Thus, the purpose of accounting centers on the collection and subsequent reporting of financial
information.

Financial reporting refers to standard practices to give stakeholders an accurate depiction

of a company’s finances, including its revenues, expenses, profits, capital, and cash flow,
as formal records that provide in-depth insights into financial information.

Users of Accounting Information

External Users and Internal Users

The active owners of business enterprises and the management use financial information for
internal decision-making purposes such as

 to evaluate the entity's performance, make financial and operational plans and implement
business decisions
 to continue or to liquidate, to infuse additional investments, to borrow from creditors
and to change business methods and strategies are some decision needs faced by the owners
and managers
 to determine whether demands of employees for improved remuneration and economic benefits
will be granted

These users who have ready access to specific types of accounting information are called
internal users. A branch of accounting called management accounting is designed to meet the
information needs of these internal users.

Because of their actual involvement in the operations of the business, the active owners and
managers may require that the information be communicated and made available to them in a form
fitting their specific decision-making needs.

Financial reporting, as discussed in the New Conceptual Framework issued in March 2018, focuses
not on the needs of the internal users but on the information needs of those who do not have
ready access to readily available information about an entity.

Users other than the management of the entity do not have ready access to financial reports
and rely heavily on negotiations and regulations to obtain information about a business
enterprise. These users, called external users, include the inactive owners, creditors and
lenders, suppliers, potential investors, taxing authorities, regulatory bodies, employees and
employee unions, financial analysts, financial advisers and consultants and the general public.
The general-purpose reports provided to this group are called the financial statements, which
are the product of a broad branch of accounting called financial accounting.

External users have diversified information needs. The enterprise's inactive owners delegate
the stewardship of the enterprise's resources to the management, and they use the financial
statements to keep track of the enterprise's financial condition and financial performance
to make decisions whether they should hold or sell their equity interests.

Present and potential creditors, through the financial information, assess the ability of the
enterprise to pay its loans and the interest attaching to such loans.

Suppliers of goods and services, on the other hand, determine whether the cost of such goods
and services will be paid when due. They are dependent upon the continuation of the enterprise
as a major customer.

Employees evaluate the financial status of the enterprise to assess the latter's ability to
provide remuneration, retirement benefits and employment opportunities.
Customers have an interest in information about the continuance of an enterprise, especially
when they have a long term involvement with, or are dependent on the enterprise as their
supplier.

A business entity is subject to government regulations mainly for the interest of public
investors and other parties dealing with it. The government and its agencies rely on financial
information to determine whether business entities comply with prescribed rules and regulations.
They are dependent on the financial information to collect the correct amount of taxes, to
determine taxation policies and to set basis for national income and similar statistics.

The public is interested in financial information about the trends and the range of business
entities' economic activities, as the general direction of business growth is indicative of
the nation's economic status.

Direct Users and Indirect Users

Other than classifying users of financial information into internal or external users may also
be categorized as direct or indirect. Users with interest use financial information as a tool
to protect their own interest in the enterprise. They include the owners, managers, creditors,
suppliers, customers, employees and taxing authority.

Others use accounting information to provide advice to or protect the interest of a direct
user. These indirect users include regulatory agencies, labor unions and financial and legal
consultants.

 regulatory agencies, e.g. Securities and Exchange Commission (SEC), protect the interest
of the investors and the public
 labor unions protect the interest of the employees
 financial and legal consultants provide advice and assistance to their clients who may be
customers, lenders or suppliers of the firm.

Although users are interested in both quantitative and qualitative information about the entity,
accounting primarily provides information that can be measured and expressed in terms of units
of measure. The monetary unit is generally the unit of measure used in communicating acc0unting
information. The quantitative or measurable information focuses on the entity's economic
resources, economic obligations, changes in economic resources and economic obligations
brought about by income and expenses and other transactions.

A reporting entity, oftentimes called accounting entity, may be a business enterprise, a

government unit, a not-for-profit organization, an individual, a unit within an enterprise,
a group of entities, and any other unit that is considered to have a personality different
from the personality of its owners, members, and employees. The concept that separates the
personality of the enterprise from that of its owners and other stakeholders is conventionally
called the "accounting entity concept". An accounting entity is capable of controlling its
own economic resources and incurring economic obligations.

Branches of Accounting

Accounting, as we all know, is the backbone of every organization. There are several branches
of accounting, and without accounting, companies wouldn’t be able to flourish and grow. The
accounting process holds together all the financial functions of an organization, leading to
accountability and order.
Not many know that accounting as a practice was established in medieval times in response to
the development of trade and commerce. The presence of accounting can be found as back as the
mid-1400, with the first accounting work published in 1494 in Italy by a Venetian monk. Therefore,
it is evident that accounting as a means of bookkeeping has been around for centuries at a
stretch. Another important fact to remember is that the principles on the basis of which
accounting was developed, haven’t changed much since they were first introduced. Assets,
liabilities, income, and reconciliation are still the fundamental basis for all accounting
processes.

Though the fundamentals haven’t changed in a long time, with the passing years, new accounting
fields and branches have come up. Reports compilation and transaction recording have evolved,
thanks to the introduction of technology, and many other new functions such as data entry and
reports building have cropped up. However, the fundamental use of accounting still remains
the same­: to receive a complete financial health snapshot of the business. As a result of
the many financial, industrial and technological advancements, different specialised and niche
branches of accounting have emerged.

Financial Accounting:
Financial accounting is a branch of accounting concerned with the supplying of financial
information about a company to external stakeholders, such as shareholders, creditors, and
the government. The financial accounting function of a company engages itself in preparing
the periodic financial statements which are then made available to the public and stakeholders.
These financial statements form the base of how well a company is positioned financially in
the market. Shareholders, bondholders, and banks rely on this information to decide if they
should continue supplying capital to the company. On the other hand, the general public uses
this information to make decisions about investments in the company. The information disclosed
in these financial statements is also used by the stock exchange and other stockbroking firms
to analyze the performance of public-listed companies and determine if investing in their stock
is a good idea.

Management Accounting:
Contrary to financial accounting, management accounting involves the supply of financial
information within the internal departments of an organization. Management accounting is a
branch of accounting that is focused on analyzing finances to prepare internal financial reports
and records that assist the managers of different departments in the decision-making process
to help drive business value. Management accounting helps make sense of the financial data
and translates this data into useful figures and statistics for the higher management and
decision-makers within an organization.

Reports can be made as per the specific needs of managers or individual functional areas, such
as marketing, sales, or manufacturing. Historic and estimated data is used to create these
reports so that comprehensive insights can be generated to help the internal management improve
business decisions. Unlike financial statements, management reports are not disclosed to or
published for external parties, instead, these are utilized by managers to improve the core
processes, such as profit evaluation of products or even departments and budgeting.

Cost Accounting:
Many people confuse management accounting with cost accounting, and though these two have a
few overlapping functions, they are completely separate branches of accounting. Cost accounting
is focused on generating information to control operations for maximizing profits and improving
the efficiency of business processes, due to which it is also called control accounting. Cost
accounting involves the recording, classifying and summarizing of the cost data via a completely
quantitative approach. It includes the management of the overall costs involved in running
a business. Cost data is used by the company management to plan and control cost operations.
Cost accounting aims to track the production cost and the fixed costs of a company. Material
(direct and indirect), labour (direct and indirect) and overhead (sales, distribution,
administration, production, etc.) are the three major elements of cost accounting.

Tax Accounting:
The branch of tax accounting has the responsibility of ensuring companies follow the tax
regulations and compliance mandated by government agencies. It handles the tax-related matters
of the business and entails the calculation of the taxable income. Tax accountants are liable
to disclose financial and other information to tax officials, as and when demanded. Enterprises
have to ensure they do not default on any national or local taxes, or they may be subject to
government penalties. Tax accountants help ensure proper compliance with tax regulations. They
also assist with tax filing and planning to decrease the company’s tax burden in the future.

Tax accounting rules greatly vary from one country to the other. Also, the government of
countries keeps updating and changing their tax laws from time to time. Therefore, tax
accountants have to be up-to-date with the current taxation laws and rules. Tax accounting
also involves advising about the effects of taxes on different business functions, legally
minimizing taxes, and dealing with legal implications, if any.

Auditing:
Auditing is one of the most crucial branches of accounting, and companies spend millions every
year to ensure auditing compliance. It involves the process of reviewing, examining, verifying
and evaluating a firm’s financial accounts and the system of internal control. This process
is carried out by auditors, who may be internal or external.

External auditors are independent firms that evaluate the accounts of a company and dole out
a fair verdict about whether or not the financial records conform to the Financial Reporting
Standards. External auditors are mainly accountable to the public outside who use the financial
statements issued by the company to make several investment-related decisions. Internal
auditors, on the other hand, are answerable to the company management. These auditors assess
if the policies set by the management are being implemented and followed. A vital task of
internal auditing is to check if employee activities are in line with the company’s business
goals. Internal auditing is usually done by the existing accountants, but some companies also
hire special resources for it.

Forensic Accounting:
Forensic accounting is often said to be an amalgamation of accounting, auditing, and
investigation. It involves the analyzing of information and records of a company’s accounts
for use in a court of law. It also involves quantifying the damages in matters of embezzlement,
frauds, and falsification of accounts as well as in cases of personal insurance, injury,
business dispute, marital clashes, environmental harms, and cyber crime, among others. Anything
that involves court litigation, investigation and dispute resolution comes within the ambit
of forensic accounting. Forensic accountants may be called in if anything suspicious surfaces
during the external audit of a company.

Fiduciary Accounting:
Fiduciary accounting is the process by which a fiduciary or a trustee of a property or an asset
communicates regular information about the financial administration of the related funds to
the parties in interest or even the government. The fiduciary has the responsibility of
periodically keeping the principals informed about the transactions and investment policies
being followed. Fiduciary accounting comes under the direct scrutiny of the law and court,
thus it has to be accurate, precise and carefully documented. It has to be transparent, as
the fiduciary has been entrusted with the responsibility of somebody else’ s property or similar
assets. Trust accounting, estate accounting, and receivership are some types of fiduciary
accounting.

Fund Accounting:
Fund accounting is a part of non-profit entities, such as governments and not-for-profit
establishments. Fund accounting is not a means of attaining profits but achieving the objectives
of the parent firm. General funds are distinguished from special funds, as general funds are
used for day-to-day activities such as paying wages, whereas special funds are used for specific
objectives and undertakings, such as hosting a special event. Non-profit firms often struggle
with scarce funds and less financial resources, thus, it is absolutely essential to have an
effective accounting system in place to ensure resources are carefully allotted.

Social Accounting:
Social accounting aims to incorporate the realization of social and environmental impact on
the day-to-day accounting activities of organizations. In the corporate setup, social
accounting is closely related to the Corporate Social Responsibility (CSR) concept. Social
accounting analyses and measures the impact of an organization on society and the environment.
It also measures the social costs and benefits of organizations’ activities. Just like any other
branch of accounting, social accounting is also a method of quantifying the performance of
a company, but in terms of social accountability.

Financial Reporting Standard Setting Process

The need to bring common basis for the system of measurement and communication of economic
activities arose when goods, services and capital investments were transferred worldwide; when
evolution of multinational companies led to the conduct of international business operations
across national borders; and when business transactions became complicated.

 June 1973-2001, International Accounting Standards Committee (IASC) was created in London
at the initiative of Sir Henry Benson. IAS developed and promoted the use and application
of the International Accounting Standards (IAS). IAS is a set of uniform global accounting
standards.

 March 8 2001, The International Financial Reporting Standards Foundation, or IFRS

Foundation, is a non-profit accounting organization. Its main objectives include the
development and promotion of the International Financial Reporting Standards (IFRS
Standards) through the International Accounting Standards Board (IASB), which it oversees.
The IFRS Foundation states that its mission is to develop IFRS Standards that bring
transparency, accountability and efficiency to financial markets around the world, and that
 their work serves the public interest by fostering trust, growth and long-term financial
stability in the global economy. The foundation was formerly named the International
Accounting Standards Committee (IASC). It is governed by a board of 22 trustees and the
IFRS Foundation Monitoring Board

 April 1 2001, IASC was replaced by International Accounting Standards Board (IASB). IASB
is an independent, accounting standard-setting body under the umbrella of the IFRS
Foundation. IASB developed the International Financial Reporting Standards (IFRS). IFRS
have replaced many different national accounting standards (e.g. IAS) around the world but
have not replaced the separate accounting standards in the United States where US GAAP is
applied.

 December 2001. A committee that assists the International Accounting Standards Board (IASB)
by providing guidance on the application and interpretation of International Financial
Reporting Standards. Its members are appointed by the trustees of the International
Accounting Standards Committee Foundation. The committee assists the IASB by working with
similar interpretative groups sponsored by national standard-setters. Before December 2001,
the Standard Interpretations Committee (SIC) was the IASB’s interpretative body. In that
month the SIC was reconstituted as IFRIC with the following specified duties:
 to interpret the application of International Accounting Standards (IASs) and
International Financial Reporting Standards (IFRSs), to provide timely guidance on
financial reporting issues not specifically addressed in IASs and IFRSs, and to undertake
other tasks at the request of the IASB;
 to carry out these duties with regard to the IASB’s objective of working actively with
national standard setters to bring about convergence of national accounting standards;
 publish, after clearance by the IASB, draft Interpretations for public comment and
consider comments made within a reasonable period before finalising an Interpretation;
 report to the IASB and obtain its approval for final Interpretations.
 to interpret the application of International Accounting Standards (IASs) and
International Financial Reporting Standards (IFRSs), to provide timely guidance on
financial reporting issues not specifically addressed in IASs and IFRSs, and to undertake
other tasks at the request of the IASB;
 to carry out these duties with regard to the IASB’s objective of working actively with
national standard setters to bring about convergence of national accounting standards;
 publish, after clearance by the IASB, draft Interpretations for public comment and
consider comments made within a reasonable period before finalising an Interpretation;
 report to the IASB and obtain its approval for final Interpretations.

Collectively, however, IFRS include the following:

 Specific International Financial Reporting Standards;
 Interpretations made by the International Financial Reporting Interpretations Committee
(IFRIC, the body that interprets the works of the IASB);
 International Accounting Standards; and
 Interpretations made by the Standing Interpretations Committee (SIC, the body that
interpreted the works of the IAS Committee).

At the present time, the IASB still issues new standards and major amendments to the existing
IFRSs.
The Standard Setting Process Adopted by the IASB (based on the IFRS Foundation website)

As published in the official website of the IFRS Foundation (eifrs.ifrs.org), the IFRS Standards
are required in more than 140 jurisdictions (countries) and permitted in many more. One of
the primary functions of the IFRS Foundation is to govern and oversee the activities of its
standard-setting body, which is the IASB. Its trustees safeguard the independence of the IASB
and ensure the financing of the organization.

The IASB follows a due process in the development of financial reporting standards. The due
process involves interested individuals and organizations around the world and comprises the
following stages:
1. setting the agenda;
2. planning the project;
3. developing and publishing the discussion paper;
4. developing and publishing the exposure draft;
5. developing and publishing the standard; and
6. afterwards, the standard is issued.

In addressing users' demand for better quality information, the IASB identifies an issue _item
to its agenda after considering the relevance of information to the users and the reliability
of the information that could be provided, whether existing guidance is available, and the
possibility of increasing convergence.

Once an item is added to the IASB's project agenda, the IASB decides whether to conduct the
project alone or jointly with another standard-setter. A working group is then established,
which may include members of staff from other accounting standard-setters.

The discussion of the working group is contained in a discussion paper (although not mandatory)
that includes a comprehensive overview of the issue, possible approaches in addressing the
issue; the preliminary views of its authors or the IASB and an invitation to comment. The issue
being discussed may result from a research project being carried by another standard setter
or it may be an active agenda carried out by the IASB. If the issue originates from another
standard setter, the publication of the discussion paper requires a simple majority vote of
the IASB members. The discussion of all technical issues takes place in public sessions (public
meetings, public hearings and public round-tables) where questions and answers session are
conducted.

The IASB considers comments received on discussion paper, results of staff research and
recommendations, and suggestions by the IFRS Advisory Council, working groups and accounting
standard setters and also suggestions arising from public education sessions. An exposure draft
is developed and voted upon.

The exposure draft is the IASB's main vehicle to consult the interested public. An exposure
draft is a proposed standard or a proposed amendment to a standard. The comment period for
major projects is usually 120 days, and for IFRIC Interpretations is usually 60 days, but may
be less in urgent cases.

The IASB makes revisions on the draft after considering the comments on the exposure draft.
When deemed necessary, a second exposure draft is developed and published, following the same
process described above. Upon reaching conclusion on the issues covered in the exposure draft,
the pre-ballot IFRS is sent to selected parties for review; after which, a near final draft
is posted on the IASB's website. Balloting, which is circularizing the near final reporting
standard to the IASB's members requires individual final review and approval of the draft.
The approved pronouncement is posted to the IASB's limited access website for an initial period
of about ten days, after which the draft is freely available online.

After issuance of an IFRS, the IASB holds regular meetings with interested parties to address
some unanticipated issues relating to implementation. The IASB may initiate studies in the
light of its review of the application Of the standard, changes in the financial reporting
environment and regulatory requirements and comments received about the quality of the IFRS.
Such studies may result in items being added to the IASB's agenda.

The IFRSs are principle-based rather than procedure-based. The International Financial
Reporting Interpretations Committee (IFRIC) was organized to interpret specific issues when
the standards do not include specific authoritative guidance. The IFRIC succeeded the Standing
Interpretations Committee (SIC) and consists of 14 voting members who act independently an
are not representing any organization or association.

The Standard Setting Process in the Philippines

Before 1981, the Philippines did not have a formal process for the development of accounting
practices. Accounting principles then were patterned from what were found in actual business
practices, mostly based on the accounting practices and principles developed by the United
States of America. It was only in late 1981, when the Philippine Institute of Certified Public
Accountants (PICPA), the accredited professional organization of certified public accountants
in the Philippines, organized the Accounting Standards Council that formalized the standard
setting process in the country.

The Accounting Standards Council (ASC) was formed on November 18, 1981 to study the accounting
standard-setting process in the Philippines. The main function of the ASC was to establish
and improve generally accepted accounting principles in the Philippines. The accounting
standards developed by the ASC were known as the Statements of Financial Accounting Standards
(SFAS). These standards were based on existing practices, research and studies undertaken by
the council, available national and international accounting literature, statements by then
International Accounting Standards Committee, and the Financial Accounting Standards Board
(FASB) of the United States of America.

The ASC was composed of eight members, representing the following organizations: PICPA,
Securities and Exchange Commission, Bangko Sentral ng Pilipinas, Board of Accountancy, and
Financial Executives of the Philippines. The members were selected by these organizations based
on some degree of recognition for technical expertise.

From the date it was organized, the ASC had been very active in the promulgation, development,
and revisions of accounting standards in the Philippines. In so doing, the ASC had been aware
of advancements in business practices and information system throughout the world.

It was during the year 1997 that our ASC made a decision to move fully to the International
Accounting Standards (IAS), although some statements of financial accounting standards adopted
by the ASC even before 1997 had already been based on the IAS.
The Philippine transition to the IAS and IFRS was gradually made. From 1997 to 2000, the ASC
developed accounting standards that were already based on IAS. In 2001, it adopted most of
the standards that had been developed by the IASC. The ASC set the year 2005 for the full adoption
of the International Accounting Standards in the Philippines. Simultaneous to this transition,
the IASC and later the IASB improved and revised IASs and IFRSs.

The Board of Accountancy, which is the body that regulates the practice of accountancy in the
Philippines, established in 2006 the Financial Reporting Standards Council (FRSC) to replace
and take over the functions of the ASC. Since then, the FRSC carries on the decision of the
ASC to converge Philippine accounting standards with the International Financial Reporting
Standards.

Under the Implementing Rules and Regulations of the Philippine Accountancy Act (Republic Act
9298), the FRSC shall be composed of a chairman and 14 members representing the following
organizations: Board of Accountancy, Securities and Exchange Commission, Bangko Sentral ng
Pilipinas, Bureau of Internal Revenue, Financial Executives of the Philippines, Commission
on Audit, and the accredited professional organization of CPAs in the Philippines (which is
presently the Philippine Institute of Certified Public Accountants or PICPA).

The FRSC formed the Philippine Interpretations Committee (PIC) in November 2006 to provide
the Council assistance in establishing and improving financial reporting standards in the
Philippines. The PIC issues implementation guidelines on the Philippine Financial Reporting
Standards.

Similar to IFRSs, the PFRSs consist of:

 Specific Philippine Financial Reporting Standards (PFRS), which are adopted from the IFRSs;
 Philippine Accounting Standards (PAS), which are adopted from the IASs; and
 Philippine Interpretations, which are adopted from the interpretations of the IFRIC and
the SIC and the interpretations of the PIC.

The PFRSs set out the recognition, measurement, presentation, and disclosure requirements
dealing with transactions and events that are important in general purpose financial
transactions. They may also set out such requirements for transactions and events that arise
mainly in specific industries.

The PFRSs are developed through a due process that involves members of PICPA, financial
executives, regulatory authorities, members of academe and other interested individuals and
organizations. Due for projects, normally, but not necessarily involves the following (Preface
to PFRSs, paragraph 19):

 consideration of pronouncement of IASB;

 formation of a task force, when deemed necessary, to give advice to the FRSC;
 issuing for comment an exposure draft approved by a majority of the FRSC members; comment
period will be at least 60 days, unless a shorter period (not less than 30 days) is considered
appropriate by the FRSC;
 consideration of all comments received within the comment period and, when appropriate,
preparing a comment letter to the IASB•, and
 approval of a standard or an interpretation by a majority of the FRSC members.
To this date, the FRSC is continuously monitoring the revisions of and the amendments to the
IFRSs to ensure that improvements in the IFRSs are being made effective in the Philippines.
Other than the FRSC, the Board of Accountancy closely monitors the implementation of the
Philippine Financial Reporting Standards.