Chapter 1
FINANCIAL STATEMENTS
Financial statements are the means by which the information accumulated and processed in
financial accounting is periodically communicated to the users.
Financial statements are a structured financial representation of the financial position and
financial performance of an entity.
General purpose financial statements
General purpose financial statements are the statements intended to meet the needs of users
who are not in a position to require an entity to prepare reports tailored to their particular
information needs.
Reports prepared at the request of management and bankers are not general purpose financial
statements because such reports are prepared specifically to meet the needs of management
and bankers.
Components of financial statements
A complete set of financial statements comprises the following components:
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Note, comprising a summary of significant accounting policies and other explanatory
information
Many entities also present reports and statements such as environmental reports and value
added statements, particularly in industries in which environmental factors are significant and
when employees are regarded as an important user group.
However, such statements and reports are not components of financial statements.
Objective of financial statements
The objective of general purpose financial statements is to provide information about the
financial position, financial performance and cash flows of an entity that is useful to a wide
range of users in making economic decisions.
Financial statements show the results of the stewardship of the management of the resources
entrusted to it.
To meet this objective, financial statements provide information about the following:
a. Assets
b. Liabilities
c. Equity
d. Income and expenses, including gains and losses
e. Contributions by and distributions to owners in their capacity as owners
f. Cash flows
Such information, along with other information in the notes, would assist users of financial
statements in predicting the entity’s cash flows and in particular their timing and certainty.
However, financial statements do not provide all the information that users may need to make
economic decisions.
The reason is that the financial statements largely portray the financial effects of past events
and do not necessarily provide nonfinancial information.
The financial position comprises the assets, liabilities and equity of an entity at a particular
moment in time.
Specifically, financial position pertains to the liquidity, solvency, and the need of the entity for
additional financing.
The financial performance comprises the revenue, expenses and net income or loss of an entity
for a period of time.
Performance is the level of income earned by the entity through the efficient and effective use of
its resources.
Cash flows are the cash receipts and cash payments arising from the operating, investing and
financing activities of the entity.
Financial reporting
Financial reporting is the provision of financial information about an entity to external users that
is useful to them in making economic decisions and for assessing the effectiveness of the
entity’s management.
The principal way of providing financial information to external users is through the annual
financial statements. However, financial reporting encompasses not only financial statements
but also other means of communicating information that relates directly or indirectly to the
financial accounting process.
Financial reports include no t only financial statements but also other information such as
financial highlights, summary of important financial figures and analysis of financial statements.
Financial reports also include nonfinancial information such as description of major products
and a listing of corporate officers and directors.
Objective of financial reporting
Under the revised conceptual framework for financial reporting, the objective of financial
reporting is to provide financial information about the reporting entity that is useful to existing
and potential investors, lenders and other creditors in making decisions about providing
resources to the entity.
General purpose financial reporting is directed primarily to the existing and potential investors,
lenders and other creditors which compose the primary user group.
The reason is that the primary users have the most critical and immediate need for information
in financial reports.
Specific objectives of financial reporting
a. To provide information useful in making investing and credit decisions about providing
resources to the entity.
b. To provide information useful in assessing the cash flow prospects of the entity.
c. To provide information about entity resources, claims and changes in resources and
claims.
Limitations of financial reporting
a. General purpose financial reports do not and cannot provide all of the information that
existing and potential investors, lenders and other creditors need.
b. General purpose financial reports are not designed to show the value of a reporting
entity but these reports provide information to help the primary users estimate the value
of the entity.
c. General purpose financial reports are intended to provide common information to users
and cannot accommodate every specific request for information.
d. To a large extend, financial reports are based on estimate and judgment rather than
exact depiction.
Responsibility for financial statements
The management of an entity has the primary responsibility for the preparation and presentation
of financial statements.
The board of directors in discharging its responsibilities reviews and authorizes the financial
statements for issue before these are submitted to the shareholders of the entity.
Management is accountable for the safekeeping of the resources and their proper, efficient and
profitable use.
Shareholders are interested in information that helps them assess how effectively management
has fulfilled this role as this is relevant to the decision concerning their investment and the
reappointment or replacement of management.
General features of financial statements
1. Fair presentation and compliance with PFRS
2. Going concern
3. Accrual basis
4. Materiality and aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation
Fair presentation
The financial statements shall present fairly the financial position, financial performance and
cash floes of an entity.
Virtually, in all circumstances, fair presentation is achieved if the financial statements are
prepared in accordance with the Philippine financial reporting standards which represent the
GAAP in the Philippines.
The application of Philippines financial reporting standards, with additional disclosure when
necessary, is presumed to result in financial statements that achieve a fair presentation.
An entity whose financial statements comply with pfrs shall make an explicit and unreserved
statement of such compliance in the notes.
Fair presentation is defined as faithful presentation of the effects of transactions and other
events in accordance with the definitions and regnotions criteria for assets, liabilities, income
and expenses laid down in the conceptual framework.
Fair presentation requires an entity:
a. To select and apply accounting policies in accordance with pfrs.
b. To present information, including accounting policies, in a manner that provides relevant
and faithful represented financial information.
c. To provide additional discloses necessary for the users to understand the entity’s
financial statements.
An entity cannot rectify inappropriate accounting policies either by disclosure of the accounting
policies used or by notes or explanatory information.
Departure from standard
In the extremely rare circumstances in which management concludes that compliance with a
requirement is a standard would be so misleading, the entity shall depart from that requirement
provided the relevant regulatory conceptual framework requires, or otherwise does not prohibit,
such a departure.
This, an entity is permitted to depart from a standard:
a. In excitement rare circumstances
b. When management concludes that compliance with the standard would be misleading.
c. When the departure from the standard is necessary to achieve fair presentation
d. When the regulatory conceptual framework requires or otherwise does not prohibit such
a departure
In such circumstances, it is incumbent upon the entity to disclose the following:
1. The management has concluded that the financial statements present fairly the financial
positions, financial performance and cash flows of the entity.
2. That the entity has compiled with applicable standards except that it has departed from a
particular requirement to achieve a fair presentation.
3. The title of the standard from which the entity has departed, the nature of the departure,
including the treatment that the standard would require, the reason why that treatment
would be so misleading and the treatment adopted.
4. For each period presented, the financial impact of the departure on each item in the
financial statements that would have been reported in complying with the requirement.
Going concern
Going concern or continuity assumption means that the accounting entity is vied as continuing
in operation indefinitely in the absence of evidence to the contrary. The going concern postulate
is the very foundation of the cost principle.
In other words, financial statements are prepared normally on the assumption that the entity
shall continue in operation for the foreseeable future.
Thus, assets are normally recorded at original acquisition cost. As a rule, market values are
ignored.
However, some standards require measurements of certain assets at fair value.
Financial statements shall be prepared on a going concern basis unless management intends to
liquidate the entity or cease trading or has no realistic option but to do so.
If the financial statements are not prepared on a going concern basis, such fact shall be
disclosed together with the measurement basis and the reason thereof.
Accrual basis
An entity shall prepare the financial statements, using the accrual basis of accounting except for
cash flow information.
Under accrual basis, the effects of transactions and other events are recognized when they
occur and not as cash or cash equivalent is received or paid, and they are recorded and
reported in the financial statements of the periods to which they relate.
Accrual basis means that assets are recognized when receivable rather that when received and
liabilities are recognized when payable rather that when actually paid.
In simple language, accrual accounting means that income is recognized when earned
regardless of when received and expense is recognized when incurred regardless of when paid.
The essence of accrual accounting is the recognition of accounts receivable, accounts payable,
prepaid expenses, accrued expenses, deferred income, and accrued income.
Materiality and aggregation
An entity shall present separately each material class of similar items.
An entity shall present separately items of dissimilar nature of function unless they are
immaterial.
Financial statements result from processing large number of transactions or other events that
are aggregated into classes according to their nature or function.
The final stage in the princess of aggregation and classification is the presentation of
condensed and classified data which form line items in the financial statements.
For example, cash on hand, petty cash fund, cash in bank and cash equivalent shall be
