FAR

• The acquisition method is used to account for business combinations, which involves recognizing and measuring the fair value of assets acquired and liabilities assumed.
• Basic concepts underlying financial statements:

  • Accounting is a service activity with the main objective of providing quantitative financial information about economic entities for making economic decisions
  • Accounting is an important section in the whole management information system
• Customary procedures involved in accounting:

  • Identification, measurement, and recording of business transactions
  • Processing quantitative information
  • Communication of information to interested users
• Procedural Steps in Accounting Cycle:

  1. Analyzing transactions

  2. Journalizing or recording

  3. Posting

  4. Preparing trial balance

  5. Adjusting entries

  6. Preparing worksheet

  7. Preparing financial statements

  8. Closing entries

  9. Preparing post-closing trial balance

  10. Reversing entries
• Generally Accepted Accounting Principles (GAAP):

  • Set of accounting rules, procedures, and standards used in recording and measuring business transactions, presenting data, and preparing financial statements
• Framework for the preparation of Financial Statements:

  • Sets out concepts underlying the preparation of financial statements for external users
  • Purpose is to facilitate consistent and logical formulations of Philippine Financial Reporting Standards
  • Scope includes objectives of financial statements, qualitative characteristics, definition, recognition, and measurement of elements, and concepts of capital and capital maintenance
• Financial statements:

  • Final product of the accounting system
  • Structured representation of financial position, financial performance, and cash flow of an entity
• Components of a complete set of financial statements:

  • Statement of financial position (balance sheet)
  • Statement of comprehensive income (income statement)
  • Statement of changes in equity
  • Statement of cash flows (cash flow statement)
  • Notes comprising a summary of significant accounting policies and other explanatory notes
• Statement of financial position (balance sheet):

  • Shows assets, liabilities, and equity
  • Investors, creditors, and other users analyze it to evaluate factors like liquidity, solvency, and capital needs
• Classification of Assets:

  • Current Assets: cash or cash equivalent, assets held for trading, assets expected to be realized within twelve months, assets intended for sale or consumption within the normal operating cycle
  • Noncurrent Assets: all other assets not classified as current
• Presentation of Current Assets:

  • Listed in order of liquidity
  • Line items include cash and cash equivalents, financial assets at fair value, trade and other receivables, inventories, prepaid expenses
• Noncurrent Assets:

  • Property, Plant and Equipment
  • Long-term investments
  • Intangible assets
  • Other noncurrent assets
• Liability:

  • Present obligation from past events requiring an outflow of resources embodying economic benefits
  • Current Liabilities: expected to be settled within the normal operating cycle or within twelve months after the reporting period
• Presentation of Current Liabilities:

  • Line items include trade and other payables, current provisions, short-term borrowing, current portion of long-term debt, current tax liability
• Noncurrent Liabilities:

  • Noncurrent portion of Long-term debt
  • Finance Lease Liability
  • Deferred tax liability
  • Long-term obligation to company officers
  • Long-term deferred revenue
• Equity:

  • Residual interest in assets after deducting liabilities
  • Reported as owner equity in a proprietorship, partners equity in a partnership, or shareholders equity in a corporation
• Forms of Statement of Financial position:

  • Report form: assets, liabilities, and equity in a downward sequence
  • Account Form: assets on the left side, liabilities and equity on the right side
• Income Statement:

  • Shows financial performance of an entity for a given period
  • Measures income earned through resource utilization
• Sources of Income:

  • Sales of Merchandise to customers
  • Rendering of services
  • Use of entity resources
  • Disposal of resources other than products
• Components of Expense:

  • Cost of goods sold
  • Distribution cost
  • Administrative expenses
  • Other expenses
  • Income tax expense
• Classifications of Expenses:

  • Distribution costs
  • Administrative expenses
• • Expenses of general accounting and credit department
  • Certain taxes
  • Contribution
  • Professional Fees
  • Depreciation of office building and office equipment
  • Amortization of Intangible Assets
  • Other expenses: not directly related to selling and administrative function
  • Examples:
  • Loss on sale of trading investments
  • Loss on disposal of property, plant and equipment
  • Loss on sale of noncurrent investment
  • Casualty loss- Flood, earthquake, fire
• Classifications of expenses:

  • Distribution costs: directly related to selling, advertising, and delivery of goods to customers
  • Includes:
  • Salesman’s salaries
  • Salesman’s commission
  • Traveling and marketing expenses
  • Advertising and publicity
  • Depreciation of delivery equipment and store equipment
  • Freight out
  • Administrative expenses: cost of administering the business
  • Includes:
  • Doubtful accounts
  • Office salaries
  • Expenses of general executives
  • Office supplies used
• Forms of income statement:

  • Functional Presentation (Cost of goods sold method): classifies expenses according to their function as part of cost of goods sold, distribution costs, administrative expenses, and other expenses
  • Natural Presentation: aggregates expenses according to their nature and not allocated among the various functions within the entity
• • Reports net cash provided or used by operating, investing, and financing activities
  • Net effect of those flows on cash and cash equivalents during the period
  • Noncash investing and financing activities are excluded
• Cash Flow Statement:

  • Cash and cash equivalents include short-term, highly liquid investments such as treasury bills, SEC registered commercial papers, and money market funds
  • Classification of cash flow activities:
  • Operating activities: key indicator of cash flow generated by operations
  • Investing activities: acquiring and selling securities and producing assets for long-term benefit
  • Financing activities: borrowing, repaying principal, obtaining resources from owners
  • Content and form of the statement of cash flows:
• Calculating Cash Flow from Operating Activities:

  • Direct Method: reports major classes of gross cash receipts and payments
  • Indirect Method: adjusts net income to reconcile it to net cash flow from operating activities
• Notes to financial statements:

  • Used to report information that does not fit into the body of the financial statements
  • Purpose is to provide necessary disclosure required by financial reporting standards
  • Presented in a systematic manner
  • Users of financial statements and their information needs:
  • Investors
  • Employees
  • Lenders
  • Suppliers and other trade creditors
  • Customers
  • Government and their agencies
  • Public
  • Management
• Framework:

  • Underlying assumptions: accrual and going concern assumptions
  • Qualitative Characteristics: attributes that make information useful to users
  • Elements for information reliability:
  • Faithful representation
  • Substance over form
  • Neutrality
  • Prudence
  • Completeness
  • Accounting constraints affecting qualitative characteristics:
  • Timeliness
  • Balance between benefit and cost
  • True and fair view/fair presentation
• Recognition Principle:

  • Four recognition principles observed in financial statement preparation:
  • Asset recognition principle
  • Liability recognition
  • Income recognition
  • Expense recognition
  • Four methods of recognizing expenses in the statements of comprehensive income:
  • Matching of cost with revenues
  • Systematic and rational allocation
  • Immediate recognition
  • Non-matching principle
• Measurement of the Elements:

  • Process of determining the monetary amount in which elements of financial statements are recognized
  • Different measurement bases employed:
  • Historical cost
  • Current cost
  • Realizable value
  • Present value
• Concept of Capital:

  • Relates to the measurement of items affecting the capital of the owners
  • Transaction approach: computes profit by deducting expenses from income
  • Capital maintenance approach: calculates profit by maintaining the value of beginning capital
  • Financial Capital: profit earned if net assets at the end exceed those at the beginning
  • Physical Capital: profit earned if physical productive capacity at the end exceeds that at the beginning
• Goodwill arises from a business combination if the total consideration paid exceeds the net fair value of the identifiable assets and liabilities acquired.
• This statement contained information about the inflow and outflow of cash during a period
• It accounts for the change in cash shown in the statement of financial position and accounts in the statement of comprehensive income affecting cash and cash equivalent
• The sources and application of cash and cash equivalents are broken down into major activities of the business
• Statement of Cash Flows

  It is useful in determining the liquidity of the business, and its ability to change cash flows in the future
• Net income of the business is considered to be of high quality if cash from operating activities is higher than the net income
• Users of Financial Statement

  • Short-term investors
  • Long-term investors
  • Lenders/ Financial Institutions
  • Suppliers/ creditors
  • Employees
  • Government
• Short-term investors are primarily interested on

  • Liquidity of the business
  • Current assets
  • Current liabilities
  • Cash flows