Conceptual Frathework Accountin \ Standards Conrado T. Valix Jose F. Peralta Christian Aris M. Valix . i SC EAN 2018 FIRST E! iONCONTENTS CHAPTER 1 THE ACCOUNTANCY PROFESSION _ Definition of accounting The accountancy profession — public accounting, private accounting and government accounting Limitation of the practice of public accountancy Accreditation to practice public accountancy Continuing professional development CPD credit units Generally accepted accounting principles Financial Reporting Standards Council Philippine Interpretations Committee International Accounting Standards Committee International Accounting Standards Board International Financial Reporting Interpretations Committee CHAPTER 2 zi CONCEPTUAL FRAMEWORK Financial reporting and assumptions Definition of Conceptual Framework Purpose of Conceptual Framework Scope of Conceptual Framework Objective of financial reporting Limitations of financial reporting Underlying assumptions — going concern, accounting entity, time period and monetary unitCHAPTER 3 CONCEPTUAL FRAMEWORK Quatitative characteristics Fundamental qualitative characteristics Relevance Faithful representation Enhancing qualitative characteristics Comparability Understandability Verifiability Timeliness Cost constraint on useful information CHAPTER 4 CONCEPTUAL FRAMEWORK Elements of financial statements Definition of elements of financial statements Asset recognition principle Liability recognition principle Income recognition principle Expense recognition principle Measurement of elements 61 92“a Definition of accounting The Accounting Standards Council provides the following definition: The accounting function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decision. The Committee on Accounting Terminology of the American Institute of Certified Public Accountants defines accounting as follows: Accounting is the art of recording, classifying ang summarizing in a significant manner and in terms ofmoney, transactions and events which are in partatleast ofa financial character and interpreting the results thereof. The American Accounting Association in its Statement of Basic Accounting Theory defines accounting as follows: Accounting is the process of identifying, measuring and communicating economic information to permit informed judgment and decision by users of the information.Important points The following important points made in the definition of accounting should be noted: 4 One - Masking: The definition that has stood the test of time is the definition given by the American Accounting Association. This definition states that the + The definition also states that accounting has a number of = components, namely: a. Identifying as the analytical component. b. Measuring as the technical component. c. Communicating as the component. Identifying ‘This accounting process is the ep pee scomnition of business activities as “account: Not all business activities are accountable, | For example, the hiring of employees, the death of the entity president and the entering into a contract are all business activities but such events are not accountable because they _ cannot be quantified or expressed in terms of a unit of measure. A is accountable or quantifiable when it has an ‘cect on assets, li i In other words, the subject matter of accounting is economic activity or the measurement of economic resources and economic obligations. . Only economic activities are emphasized and recognized in accounting. Sociological and psychological matters are beyond the province of accounting.jons . nsaction 7 ' nternal tra External and i red to 18 fransaction, re refer Economic activities of an Pexternal and internal which may be classified as nsactions are: Examples of external tral a. Purchase of goods from a supplier b. Borrowing money from @ ban! c. Sale of goods to a customer d. Payment of salaries to employees : Payment of taxes to the government! Internal transactions are the economic activities that take place entirely-within-the entity. Production and casualty.loss are ex: transactions. ‘ Production is the process by which resources are transformed into products. ’ i Casualty is any sudden and unanticipated loss from fire, flood, earthquake and other event ordinarily termed as an act of God. Measuring This accounting process is the assigning of peso amounts to the accountable economic transactions and events. If accounting information is to be useful, it must be expressed in terms of a common financial denominator. amples of internal Financial statements without monetary amounts would be largely unintelligible or incomprehensible. The Philippine peso is the unit of measuring accountable” economic transactions. I The measurement bases are historical-cost, current cost" realizable value and present value. Historical cost is the most common measure of financial transactions. -Communicating is the i listributing Identifying and measuring are pointless if the information contained in the accounting records cannot be communicated in some form to potential users. Actually, the communicating process is the reason why accounting has been called the “universal language of business”. Implicit in the communication process are the recording, and summarizing-aspects of accounting. Recording or journalizing is the process-of-systematically maintaining”a re onomic: bus after they have been identified and measured. ‘Classifving is the sorting or grouping-of-similar-and interrelated economic transactions into.their respective classes. “Classifying is accomplished. by.posting tothe ledger. The ledger is aygroup”ofvaccount’s which are systematically categorized into asset accounts, liability accounts, equity accounts, revenue accounts and expense accounts. Sunimiarizing is the preparation of financial statements which include the statement of-financial-position, income statement, statement of comprehensive income, statement of changes in equity and statement of cash flows. Accounting as an information system ig is an information system that measures business Activities, processes information into reports and communicates the reports to decision makers. A key product of this information system is a set of financial, atements — the documents that report financial information about an entity to decision makers. - Financial reports tell us how well an entity is perform ing in terms of profil and loss and where it stands in financial terms. aOverall objective of accounting ~ The fnonilinforetion a 0b is to sr that tenoele An accountant’s primary task is to supply financial information so that the statement users could make informed Judgment and better decision. The essence of accounting is decision-usefulness. Investors and other users are interested in financial]. accounting information necessary in making important and significant economic decisions, THE ACCOUNTANCY PROFESSION Lb At present, is the law regulating the . Practice of accountancy in the Philippines. ‘ This law is known as the @Philippine Accountaney: Act of Accountancy has developed as a profession attaining a status equivalent to that of law and medicine, fi 1 In the "Philippines, in order to qualify to practice the accounta profession, a person must finish a degree in Bachelor of Science in Accountancy and pass a very difficult government examination given by the Board of Accountancy, ‘The Board o! the body authorized promulgate rules ffecting the practice of the accountancy profession in the Philippines, The Board of Accountancy is responsible for preparing and grading the Philippine CPA examination, ms | - . This computer-based examination is offered twice a year, one in May and another one in October, in authorized testing centers around the country.Limitation of the practice of public accountancy Single practitioners and partnerships for the practice of public accountancy shall be registered certified public accountants in he Philippines. ° 5 » A certificate/of acereditation shall be issued to certified public accountants in public practice only upon showing in accordance with rules and regulations promulgated by the Board of Accountancy and approved by the Professional Regulation Commission that such registrant has acquired a minimum of three years of meaningful experience in any of the areas of public practice including taxation. 3 4 _oiebiabhie i The Securities and Exchange"Coihmssion shill ndt FeBister any corporation organized for the practice of, public accountancy. © pahneeip + SEL CoP regi Accreditation to practice public accountancy Certified public accountants, firms and partnerships of certified public accountants, including partners and staff members thereof, are required to register with the Board of Accountancy and Professional Regulation Commission for the practice of public accountancy. The Professional Regulation Commission upon favorable recommendation of the Board of Accountancy shall issue the Certificate of Registration to practice public accountancy which shall be valid for 3 years and renewable every 3 years upon payment of required fees. Certified Public.Accountants generally p. ractice their profession in three main areas, namely: a. Public accounting b. Private accounting c. Government accounting.PUBLIC ACCOUNTING The field of public acm ting or public accountancy is com, of indi, tal pee fall accounting firms and large at Public acco nam untants usually offer three kinds of Services, ‘Y Guditing, taxation and . Asa matter of fact, large multinational accounting firms have Separate division for each of these services Auditing ‘@taiting has traditionally been the primary service offered ¥ MOst public accounting practitioners. y auditing is the attest function of independent CPAs. The Bureau of In statements to accor Banks and ot! audit by borrower ternal Revenue requires audited financial mpany the filing of annual income tax return, ther lending institutions fre an independent CPA before gral quently require an ting a loan to the Creditors and Prospective investors place considerable reliance on audited financial statements on making economic decision. . Taxation Taxation service includes the preparation of annual income «tax returns and determination of taw consequences of corte: proposed-business-ent The CPA not-infrequently represents the client in tax investigations. To offer this service effectively and efficiently, the public accountant must be thoroughly familiar with the tax laws and regulations and updated with changes in taxation law and court cases concerned with interpreting taxation law. 8Management advisory services Management advisory-services have become increasingly important in recent years although audit and tax services are undoubtedly the mainstay of public accountants The term management advisory services has no precise coverage but is used generally to refer to i Specifically, management advisory services include: a. b. Ge d e f. & Advice on installation of computer system Quality control Installation and modification of accounting system . Budgeting Forward planning and forecasting Design and modification of retirement plans . Advice on mergers and consolidations PRIVATE ACCOUNTING Many Certified Public Accountants are employed in business entities in various capacity as accounting staff, chief accountant, internal auditor and controller. The highest accounting officer inan entity is known as the controller. a The major objective of the private accountant is to assist management in planning and controlling the entity's operati Private accounting includes maintaining the records, producing the financial reports; preparing the budgets and ee sSFSFf ‘The private accountant has also the responsibility for the determination of the various taxes the entity is obliged to pay. :xOVERNMENT ACCOUNTING Government accounting eneompasses aun oce88 analyzing, classifying, summarizing and communica| ‘ng aly transactions involving the receipt and. disposition of government. funds and property. and interpreting 4, results thereof, The focus of government accounting is the custody ang administration of public funds. mn of public fun . Many Certified Public Accountants are employed in many ranches of the government, more particularly: Bureau of Internal Revenue Commission on Audit Department of Budget and Management Securities and Exchange Commission Bangko Sentral ng Pilipinas Ppore CONTINUING PROFESSIONAL DEVELOPMENT (CPD) Republic Act No, 10912 is the law mandating and strengthening the continuing professional development Program for all regulated professions, including-the accountancy profession. All certified public accountants shall abide by the requirements, rules and regulations on continuing professional development to be promulgated by the Board of Accountancy, subject to the approval of the Professional Regulation Commission, in coordination with the accredited national professional organization of certified public accountants or any duly accredited educational institutions. Continuing professional development refers to the inculeatio and acquisition of advanced knowledge, skill, proficiency, atid ethical and moral values: after the initial registration of the Certified Public Accountant for assimilation into professional practice and lifelong learning. Continuing professional development raises and enhances its technical skill and competence of the Certified Public Accountant. 10CPD credit units The CPD credit units refer to the CPD credit hours required for the renewal of CPA license and accreditation of a CPA to practice the accountancy profession every three years. ‘Under the new BOA Resolution, all Certified Public Accountants regardless of area or sector of practice shall be required to comply with WARSRPrcredtitmn nity in compliance period of three years. However, the initial implementation of the 120 CPD credit units is gradual in the following period: 2017 80 credit units 2018 100 credit units 2019 120 credit units Excess credit units earned shall not be carried over to the next three-year period, except credit units earned for masterak and doctoral-degrees. Iti is to be emphasized abat the Gaccbiatiesgelancisocio nl Development has become-mandatory-for-Certified Public Accountants. es The Continuing Professional Development is required for the renewal of CPA license | and accreditation of CPA to practice the accountancy profession. Exemption from CPD ‘A CPA shall be permanently exempted from CPD requirements upon reaching the age of 65 years. However, this exemption applied only to the renewal of CPA license and not for the purpose of accreditation to practice e the accountancy profession. 1A 7 ccounting versus auditing In | o a broad sense, accounting embraces auditing. Avaitine : . uditing is one of the areas of accounting specialization In a limited sense, accounting is essentially constructive ;, n financial statements are ae Accounting ceases whe already prepared. On the other hand, auditing is analytical: The work of a, auditor begins when the work of the accountant ends. ‘ After the financial statements are prepared, the auditor will begin to perform the task of auditing. The auditor examines the financial statements to ascertain whether they are in conformity with generally accepteg accounting principles. Accounting versus bookkeeping . Bookkeeping-is procedural and-largely. concerned-with development and-maintenance.of accounting-records. Bookkeeping is the “how” of accounting. ‘ a 4 Accounting is conceptual and is concerned with the-why, 3 reason or justification for-any action adopted. . is Bookkeeping is a procedural element of accounting as arithmetic is a procedural element of mathematics. Accounting versus accountancy the two terms are synonymous because they Broadly speaking, field of accounting theory and practice. both refer to the entire Technically speaking, however accountancy refers to the " profession of accounting practice. particular field of Accounting is used in reference only to a ting an! accountancy such as public accounting, private accoun government accounting. 12GeeSSsSsSa{E_E_—hlmlmltC—(i‘i‘iO™OCOCOOCOC~™ Financial accounting versus managerial accounting e ansactions and the eventual preparation of financial statements. Financial accounting focuses on general purpose reports known as financial statements intendet external users. Financial accounting is the area of accounting that emphasizes reporting to ereditors and investors. .— oo". Managerial accounting is the accumulation and preparation of financial reports for-internal-users-only. In other words, managerial accounting is the area of accounting that emphasizes developing accounting information foruse within an entity. ° GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ot Accounting has evolved through time changing with the niceds ; me ; of society. As new types of transactions occur in trade and commerce, accountants develop rules and procedures for recording them. These accounting rules, procedures and-practices came to be known as generally accepted.accounting principles or simply GAAP. ‘The principles have developed on the basis of experience, reason, custom, usage and practical necessity. «roy Generally accepted accounting principles represent the rules, procedures, practice and standards=followed in the preparation and presentation of financial-statements. Generally accepted accounting principles are like laws that must be followed in financial reporting. ‘The process of establishing GAAP is a political process which incorporates political actions of various interested user groups as well as professional judgment, logic and research. 13, aPO r Purpose of accounting standards j ards is to ide ‘The overall puxpose of accounting standarde is to ide pi Proper accounting practices for the p Presentation of financial statements. ‘standin, . = ate a common under: gs Accounting standards cre: statement, between preparers and users of finan’ particularly the measurement of assets and liabilities. A set of high-quality accounting standards is a necessity to ensure comparability and uniformity in financial statements based on'the same financial information. FINANCIAL REPORTING STANDARDS COUNCIL, In the Philippines, the development of generally accepted accounting principles is formalized initially through the creation of the Accounting Standards Council or ASC. The Financial Reporting Standar Is Council or FRSC now replaces the Accounting Standards Council. The FRSC is the accounting standard setting body created by the Professional Regulation Commission upon recommendation of the Board of Accountancy to assist the Board of Accountancy in carrying out its powers and functions provided under R.A. Act No. 9298. oe < The main function is to establish and improve accounting standards that will be generally accepted in the Philippines. The accounting standards promulgated by the Financial Reporting Standards Council-constitute the="highest hierarchy" of generally accepted accounting principles in the Philippines. The approved statements of the FRSC are known as Philippine Accounting Standards or PAS and Philippine Financial Reporting Standards or PFRS, 14Composition of FRSC Board of Accountancy a Securities and Exchange Commission Bangko Sentral ng Pilipinas Bureau of Internal Revenue Commission on Audit Major organization of preparers and users of financial statements — Financial Executives Institute of the Philippines or FINEX. ‘Accredited national professional organization of CPAs: , Public Practice Commerce and Industry Academe or Education Government Total The Chairman and members of the FRSC shall have a term of 3_years renewable for another term. Any member of the ASC shall not be disqualified from being appointed to the FRSC. Philippine Interpretations Committee ‘The Philippine Interpretations Committee or PIC was formed and has replaced the ittee or IC formed by the Accounting ounce! ay 2000. The role of the PIC is to prepare interpretations of PFRS for approval-by the FRSC and to provide-timely.guidance on financial reporting issues not-specifically addressed in current -PFRS. In other words, interpretations are intended to give italiv ce on issues that are likely to receive authoritative guidan' diverge oa are because the standards (0 not provide specific and clearcut rules and guidelines. The counterpart of the PIC in the United Kingdom. is the International Financial Reporting Interpretations Committee or IFRIC which has already replaced the Standing Interpretations Committee or SIC. I Ieo 03 20 80 Ini Stanc 15INTERNATIONAL ACCOUNTING STANDARDS COMyy is an independent priv body, wi oF Taso fj private sector body, with the objective og achieving-uniformity im the accountin reporting’around the world: a It was formed in June 1973 through an agreement made professional accountancy bodies from Australia, Canaq, France, Germany, Japan, Mexico, the Netherlands, thy United Kingdom and Ireland, and the United States of America. The IASC is headquartered in London, Uniteg Kingdom. Objectives of IASC a. To formulate and publish in the public interest accounting | standards to be observed in the presentation of financial _ statements and to promote their worldwide acceptance q ni and observance. - Consequently, financial reporting should provide information that is useful in assessing the amount, timing and uncertainty of prospects for future net cash inflows to the entity. Economic resources and claims . 7 . General purpose financial reports provide information about the financial position of a reporting entity. _Financial position is information about the entity's economic resources and the claims against the reporting entity. resource ee ee . The economic resources are the assets and the claims are the liabilities and equity of the entity. ee eee In other words, the financial position comprises the assets, liabilities and equity of an entity at a particular moment in time. — . 38 iInformation about the nature and amounts of an entity's economic resources and claims can help users identify the entity's financial strength and weakn Otherwise stated, information about financial position can help users to assess the entity’ 's liquidity, solvency and the need for additional financing. Liquidity is the availability of cash in the near future to cover currently maturing obligations. Solvency is the availability of cash over a long term to meet financial commitments when they fall due. Information about priorities and payment requirements of existing claims can help users to predict how future cash flows will be distributed among those with a claim against the reporting entity. Changes in economic resources and claims General purpose financial reports also provide information about the effects of transactions and other events that change the economic resources and claims. Changes in economic resources and claims result from 01 e and from other events or transactions, such as issuing debt or equity instruments. The financial per} formance of an entity comprises revenue, expenses and net income or loss for a period of time. In other words, financial performance is ‘the level of income cared by.the-entity through the efficient and effective use of its resources. ‘The financial performance of an entity is also known as results: of operations and is portrayed in the income statement and 39Usefulness of financial performance Information about financial performance helps users*to understand the return that the entity has produced on:the economic resources. Information about the return the entity has ee provides an indication of 1-ma discharged its responsibilities to make efficient and elective use of the entity's economic resources. Information about past financial performance is usually helpful in-predicting-the future returns on the entity's economic resources. Information about financial performance during a period is useful is assessing the entity's ability to generate future cash inflows from. operations. Accrual accounting Accrual accounting depicts the effects of transactions and Other events and circumstances on an entity's economic resources and claims in the periods in which those effects - oceur even if the resulting cash receipts and payments occur in a different period. In other words, under*the accrual basis, the effects-of» transactions and other.events are recognized when they occur and not as.cash is-received or paid. — Simply stated, accrual_accounting means thatipcome is necounized-when-eor ned.regardless of when received and sce per year or a pe: celve months. The “one-year period” is traditionally the accounting period because usually it is after one year that government reports are required. The accounting period may be a calendar year or a natural business year. A calendar year is a twelve-month period that“ends on December 31. A natural business year is a twelve-month period that ends on any month when the business is at the lowest or experiencing slack season. 44Monetary unit ~ The quantifiability-aspect means that the assets,-liabilities, y a ys i i S. How awkward to see financial statements without any common unit of measure. Such statements would be largely unintelligible and incomprehensible. The stability-of-the=peso-assumption means that the The stable peso postulate is actually an amplification of the going concern assumption so much so that ‘adjustments are unnecessary to reflect any changes in purchasing power. The accounting function is to ecountefor nominalpasos-arly and_not for constant pesos or Changes in i ner. In today's world, the assumption that the peso is a stable measure over time is not necessarily valid. Consider an equipment that was imported 10 years ago from the United States for $100,000 when the exchange rate was P35 to $1 or an equivalent of P3,500,000. If the same equipment is purchased now and assuming there is no change in the $100,000 purchase price, the replacement cost in terms of pesos would be in the vicinity of P5,000,000, considering a current exchange rate of P50 to $1. Obviously, there is a significant gap between historical cost and current replacement cost. In this regard, an entity may choose the revaluation model 2 z as an accounting policy.QUESTIONS 1, What is the meaning of Conceptual Framework? é 2,What are the basic purposes of the Conceptual ~ Framework? a 3. Explain the authoritative status of the Conceptual Framework. 4. Explain the "primary users” and their information needs. 5. Explain the “other_users” and their information needs. 6 What is the scope of the Conceptual Framework? e 7. Explain financial reporting. 8. Distinguish financial reports and financial statements. . What is the overall objective of financial reporting? 10. What are the specific objectives of financial reporting? 11. Explain financial position. 12. Explain liquidity and solvency. 13. Explain financial performance. 14, Explain accrual accounting. 15. What are the limitations of financial reporting? 16. Explain accounting assumptions. 17. Explain going concern assumption. 18. Explain accounting entity assumption. 19. Explain time period assumption. 20. Explain monetary unit assumption. 46PROBLEMS Problem 2-1 Multiple choice (ACP) 1 ne ~ bs The Conceptual Framework deals with all of the following, except a. ‘The objective of financial reporting b. The qualitative characteristics of useful financial information c. The definition, recognition and measurement of the elements of financial statements c d. Supplementary information . Which statement is true concerning the Conceptual Framework for Financial Reporting? a. The Conceptual Framework is not a reporting standard and does not define standard for any particular measurement or disclosure issue. b, The Conceptual Framework is concerned with general purpose financial statements including consolidated financial statements. c. Nothing in the Conceptual Framework overrides any specific Philippine Financial Reporting Standard. d. All of these statements are true about the Conceptual Framework. Which is not a purpose of the Conceptual Framework? a. Toassist the FRSC in developing accounting standards that will represent GAAP in the Philippines. b. To assist the FRSC in the review and adoption of existing international accounting standards. c. To assist auditors in forming an opinion as to whether financial statements conform with Philippine GAAP. d. To assist the Board of Accountancy in promulgating rules and regulations affecting the practice of public accountancy. Which is a basic purpose of the Conceptual Framework? a. To assist users of financial statements in interpreting the information contained in the financial statements. b. To provide information to those interested in the work of the FRSC in the formulation of PFRS. c. To assist preparers of financial statements in applying accounting standards. d. All of these are considered basic purpose of the Conceptual Framework. 47Problem 2-2 Multiple choice (IFRS) 1. What is the authoritative status of the Conceptugy Framework? a. The Conceptual Framework has the highest level of authority. . " b. In the absence of a standard or an interpretation that specifically applies to a transaction, the Conceptual Framework shall be followed, : ¢. In the absence of a standard or an interpretation that specifically applies to a transaction, management shal] consider the applicability of the Conceptual Framework in developing and applying an accounting policy that results in information that is relevant and faithfully represented. ; d. The Conceptual Framework applies only when the IASB develops new standards. 2. The Conceptual Framework is intended to establish a. GAAP in financial reporting. . b. The meaning of "present fairly in accordance with AAP", c. The objectives and concepts for use in developing standards of financial accounting and reporting, d. The hierarchy of sources of GAAP. 3. A Conceptual Framework should a. Lead to uniformity of financial statements , b. Eliminate alternative accounting principles. c. Guide multinational entities in developing generally accepted. auditing standards, d. Define the basic objectives, terms and concepts of accounting. 4. Which is not a purpose of the Conceptual Framework? a. To provide definitions of key terms and fundamental concepts. b. To provide specific guidelines for resolving situations not covered by existing accounting standards. c. To assist accountants in selecting among alternative accounting and reporting methods. d. To assist the International Accounting Standards Board in the standard-setting process. 48Pr lL w oa oblem 2-3 Multiple choice (IAA) In the Conceptual Framework for Financial Reporting, what provides the "why" of accounting? a. Measurement and recognition concept b. Qualitative characteristic of accounting information c. Ilement of financial statement d. Objective of financial reporting . The underlying theme of the Conceptual Framework is ion usefulness b. Understandability c. Timeliness d. Comparability . What is a benefit of having a Conceptual Framework? a. To enable profession to more quickly solve emerging practical problems. b. To provide a foundation from which to build more useful standards. c. To enable the standard setting body to issue more useful and consistent pronouncements over time. d. All of these can be considered benefit from a Conceptional Framework. . Which of the following is not a benefit associated with the Conceptual Framework? a. A Conceptual Framework should increase users' understanding and confidence in financial reporting. b. Pratical problems should be more quickly solvable. c. A coherent set of accounting standards should result. d. Business entities will need far less assistance from accountants, Which statement is not true concerning the Conceptual Framework? a. The Conceptual Framework should be a basis for standard setting. b. The Conceptual Framework should allow practical problems to be solved more quickly. ce, The Conceptual Framework should be based on fundamental truth derived from the law of nature. d. The Conceptual Framework should increase users’ understanding and confidence in financial reporting. 49a Problem 2-4 Multiple choice (ACP) 1. Users of financial reports include which of the following Creditors Creditors and government agencies Creditors and unions Creditors, government agencies and unions ae oe 2. The primary users of financial information include Existing and potential investors Existing and potential lenders and other creditors c. User group such as employees, customers, governments and their agencies, and the public d. Existing and potential investors, lenders and other creditors ep Which group is not among the external users for whom financial statements are prepared? 2 a. Customers b. Suppliers c. Employees All of these are external users of financial statements 4, Which of the following is an internal user of financial information? Board of Directors . Shareholder c. Holder of bonds ‘ Creditor with long-term contract 5. These users require information on risk and return provided by their investment. a. Investors b. Employees c. Lenders d. Customers 50bility of the entity in order to assess © provide remuneration, retirement eir agencies interested in information that enables sess whether their loans, the related interest and other amounts owing to them will be paid du Lenders and other creditors Borrower Trade creditors Owners se users are interested in information about the continuance of an entity, especially when they have a lon lvement with or are dependent on the Employ Trade unions Suppliers 9. These usera are interested in information in crder to ulate the activities of an entity, determine taxation policies and provide a basis for national statistics. a. Governments and their agencies b. Major organization of users c. Bureau of Internal Revenue d. Department of Finance 10. These. users need information on trends and recent developments where an entity makes a substantial contribution to the local economy providing employment and using local suppliers. The public / ; Governments and their agencies Finance entities Private entities a b, ¢ d 51a 1. The overall objective of financial reporting is to Provide information Problem 2-5 Multiple choice (IAA) a. That is useful for decision makin | b. About assets, liabilities and equity of an entity, ¢. About financial performance during a period. d at allows owners to assess management performanca 2. The primary focus of financial reporting has been op meeting the needs of which. of the following groups? a. Management b. Existing and potential investors, lenders and other creditors c. National taxing authorities d. Independent CPAs wo . The primary objective of financial reporting is to Provide useful information to a. Management b. Capital providers c. Regulation a) None of these users ¥ 4. Which is an objective of financial reporting? -(&) To provide information that is useful in making investing and credit decisions. b. To provide information that is useful to management, ¢. To provide information about the potential users. d. To provide information about ways to solve internal and external conflicts about the entity. 5. What is an objective of financial reporting? a. To provide information that is useful to management in making decisions. b. To provide information that clearly portrays nonfinancial transactions, ce. To provide information that is useful to assess the amount, timing, and uncertainty of prospective cash receipts. | il d. To provide information that excludes claims agains the resources. 526. An objective of financial reporting is to provide 1 st @ Ss a. Information about the investors in the entity. b. Information about the liquidation value. c. Information that is useful in assessing cash flow prospects. d. Information that will attract new investors. . Assessing cash flow prospects is interpreted to mean a. Cash basis accounting is preferred over accrual basis. b. Information about the financial effects of cash receipts and cash payments is generally considered the best indicator of ability to generate favorable cash flows. c. Over the long run, trends in revenue and expenses are generally more meaningful than trends in cash receipts and disbursements. d. All of the choices are correct regarding assessing cash flow prospects. In measuring financial performance, accrual accounting is used because a. Cash flows are considered less important. b. It provides a better indication of ability to generate cash flows than cash basis. c. It recognizes revenue when cash is received. d. It is one of the implicit assumptions. The most useful information in predicting future cash flows is Information about current cash flows Current earnings based on accrual accounting Information regarding the accounting policies used Information regarding the results obtained by using a wide variety of accounting policies Bere ‘The accrual basis of accounting is most useful for a. Determining the amount of income tax liability. b. Predicting the short-term financial performance. Predicting the long-term financial performance. Determining the amount of dividends to be declared. ao 53Problem 2-6 Multiple choice (AICPA Adapted) 1. The objectives of financial reporting are based on The need for conservatism . Reporting on management stewardship Generally accepted accounting principles . The needs of the users of the information Boe. - Which is not a specific objective of financial reporting? a, Financial reporting shall provide information about _ entity resources, claims against those resources ang changes in them. 7 b. Financial reporting shall provide information Useful in evaluating management stewardship. § c. Financial reporting shall provide information useful in investment, credit and similar decision. 2 d, . Financial reporting shall provide information useful. in assessing cash flow prospects, . Which of the following is not an objective of financial reporting? | a. To provide information about an entity’s assets and claims against those assets b. To provide information that is useful in assessin; entity’s sources and uses of cash c. To provide information that is useful in lending and — investing decisions . To provide information about the liquidation value of an entity gan 544, Financial reporting pertains to information about a. Individual business entities, rather than to industries or an economy as a whole or to members of society as consumers. b. Business industries, rather than to individual entities or an economy as a whole or to members of society as consumers. c. Individual business entities, industries, and an economy as a whole, rather than to members of society as consumers. d. An economy as a whole and to members of society as consumers, rather than to individual entities or industries. 5. During a period when an entity is under the direction of a particular management, financial reporting directly provides information about a. Both entity performance and management performance b. Management,performance but not entity performance c. Entity performance but not management performance d. Neither entity performance nor management ' performance. 55Problem 2-7 Multiple choice (IAA) k. 2 Which best describes the term going concern? a. When current liabilities exceed current assets b. The ability of the entity to continue in operation fo, the foreseeable future ; c. The potential to contribute to the flow of cash ang cash equivalents to the entity d. The expenses exceed income Which is an implication of the going concern assumption? a. The historical cost principle is credible. b. Depreciation and amortization policies are justifiable and appropriate. c. The current and noncurrent classification of assets and liabilities is justifiable and significant. d. All of these are an implication of going concern. . The relatively stable economic, political and social environment supports a. Conservatism b. Materiality x c. Timeliness d. Going concern |. Which of the following is mot a basic assumption underlying financial accounting? a. Economic entity assumption b. Going concern assumption c. Periodicity assumption d. Historical cost assumption . Which basic assumption may not be followed when 2a entity in bankruptcy reports financial results? Economic entity assumption Going concern assumption Periodicity assumption . Monetary unit assumption Be op 56. The economic entity assumption ~ 10, a. Is inapplicable to unincorporated businesses. b. Recognizes the legal aspects of business organizations. c. Requires periodic income measurement. d. Is applicable to all forms of business organizations. What is being violated if an entity provides financial reports in connection with a new product introduction? a. Economic entity b. Periodicity c. Monetary unit d. Continuity Which underlying assumption serves as the basis for preparing financial statements at regular artificial points in time? a. Accounting entity b. Going concern c. Accounting period d. Stable monetary unit Which basic accounting assumption is threatened by the tence of severe inflation in the economy? a, Monetary unit assumption b. Periodicity assumption c. Going concern sumption d. Economic entity assumption Inflation is ignored in accounting due to a. conomic entity assumption b. Going concern assumption c. Monetary unit assumption d. Time period assumptionProblem 2-8 Multiple choice (AICPA Adapted) 1. The concept of accounting entity is applicable a. Only to the legal aspects of business organizations b. Only to the economic aspects of business organizations c. Only to business organizations d. Whenever accounting is involved 2. When a parent and subsidiary relationship exists, consolidated financial statements are prepared in recognition of Legal entity Economic entity Stable monetary unit Time period po op 3. The valuation of a promise to receive cash in the future at present value is valid because of what accounting concept? a. Entity b. Time period c. Going concern d. Monetary unit 4, What is the accounting concept that justifies the usage of accruals and deferrals? Going concern Materiality Consistency Stable monetary unit ae op 5. During the lifetime of an entity accountants produce financial statements at arbitrary points in time in accordance with what basic accounting concept? a. Accrual b, Periodicity c. Unit of measure d. Continuity 58Problem 2-9 (IAA) For each situation, identify the underlying assumption involved. 1. a The operations of a saving bank are being evaluated by the Bangko Sentra] ng Pilipinas. During the investigation, the BSP has determined that numerous loans made by top management were unwise and have seriously endangered the future of the saving bank. The parent entity in Manila has a subsidiary in Japan. The financial statements of the subsidiary are translated to pesos for consolidation with the financial statements of the parent entity at year-end. //« " A machinery was imporced from USA at a certain cost five years ago. Because of inflation, the machinery has now a current replacement cost which is very much higher than the historical cost. Management would like to report the machinery at current replacement cost. | ¢ ™ An entity has experienced a drastic reduction in revenue by reason of a long dry spell in the area where the entity grows its tobacco. The management decided to wait until next year and present financial statements for a two-year period rather than prepare now the traditional twelve-month financial statements. *' A subsidiary was exhibiting poor financial performance for the current year. In an effort to increase the subsidiary's reported income, the parent entity purchased goods from the subsidiary at twice the normal markup. be ag Kt 59Problem 2-10 Identification (IAA) Identify the assumption that is most clearly violated by gh, accounting practice. 1. An entity decided to publish financial statements only iz the years when it had good news to report. © teen 2. An entity reported inventory, property, plant ang equipment and intangible assets at current value at year-end. 3. An electronics entity owned by a proprietor reported the cost of the proprictor's swimming pool as an asset of the entity. 4. An entity prepared financial statements adjusted for changes in purchasing power. 5. A mining entity kept no accounting records after starting business. The entity is waiting until the mine is exhausted to determine the success or failure of business. * yy. .¢« Problem 2-11 Identification (IAA) Identify the assumption defined or described. i. An entity reported financial statements in nominal pesos that have mixed rather than uniform amount of purchasing power. 2, A multinational entity published a complete set of financial statements at least once a year, regardless of whether the financial results were good or bad. \inu ia 3. The pesos of today can buy as much goods and services ; the pesos five years ago. ’ 4, An accounting entity is viewed as continuing in operati in the absence of evidence to the contrary. An accounting practitioner mixed personal accounting records with the records of the accounting practice. a 60 }CHAPTER 3 - CONCEPTUAL FRAMEWORK ‘Qualitative characteristics TECHNICAL KNOWLEDGE To identify the qualitative characteristics of accounting information. To identify the fundamental qualitative characteristics. To identify the enhancing qualitative characteristics. To understand the cost constraint on useful information. 61Definition Qualitative characteristics are the qualities or attributes, make financial accounting information useft 73, In deciding which information to include in finang statements, the objective is to ensure that the information is usehy to the users in making economic decisions. Under the Conceptual Framework for Financial Reporting i cteristics are classified into ; racteristics and enhancing qualitatiy, a gnhanci qu characteristics. Fundamental qualitative characteristics The fundamental qualitative characteristics. content or substance of financial information. ¥ The fundamental qualitative characteristics are relevance and faithful representation. 3 Information must be both relevant and faithfully represented _ if it is to be useful, 4 Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good decisions. % Application of qualitative characteristics The most efficient and effective process of applying the _ fundamental qualitative characteristics would usually be: First, identify an economic phenomenon that has the potential to be useful. Second, identify the type of information about the. phenomenon that would be most relevant and can faithfully represented. Third, determine whether the information is available. 62Relevance . » In the simplest terms, inlowcarconipailanaopnetinnnbatie information to influence a decision. To be relevant, the financial information must be capable of making a difference in the decisions made by users. In other words, relevance requires that the financial information should be related or pertinent to the economic decision. ° Information that does not bear on an economic decision is useless. To be useful, information must be relevant to the decision making needs of users. For example, broadly, the statement of financial position is relevant in determining financial position, and the income statement is relevant in determining performance. More specifically, the earnings per share information is more relevant than book value per share in determining the attractiveness of an investment. ae Ingredients of relevance Financial information is capable of making a difference ina décision if it has predictive value and confirmatory value. — Financial information has predictive value if it-can-be-used as an input to processes employed: by users to predict-future “outcome. In other words, financial information has predictive value when it can help users increase the likelihood of correctly or accurately predicting or forecasting outcome of events. For example, information about financial, position and past performance is frequently used in predicting dividend and wage payments and the ability of the entity to meet maturing commitments. The net cash provided by operating activities is valuable in predicting loan payment or default. 63Financial information has saphenconperelooninirrroias Vi 01 y dback: about previous:e\ —_—_——— In other words, financial information has confirmatory Value when it enables users confirm or correct earlier expectations For example, a net income measure has confirmatory valye ; it can help shareholders confirm or revise their xPeCtation about an entity’s ability to generate earnings. Often, information has both predictive and confirmatory value The predictive and-confirmatory roles of information: arg interrelated. An example is an interim income statement which Provides feedback about income to date and serves as a basis fo, predicting the annual income. The interim income statement for the first quarter shows net income of P2,000,000. This is the confirmatory value, If this trend continues for the entire year, it is logical tp assume that the net income after four quarters or one Year would be P8,000,000. This is the predictive value. Materiality Materiality is a practical rule in accounting which dictates that strict adherence to GAAP is not required when the items and fairness « nancial statements. _ The materiality concept,is also known as the doctrine of convenience. ais —i Materiality is really a @Wantitative "threshold" linked very closely to the qualitative characteristic of relevance. The relevance of information is affected by its ature and ‘materiality. E besedon thenah na a based on the nature or magnitude or both of the items t0 W! the information relates. The Conceptual Framework does not specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation. 64