THEORY OF ACCOUNTS

Module 1 Overview of Accounting and Introduction to IFRS

1.1 Overview of Accounting ............................................................................................. 1

1.2 The Accounting Process ............................................................................................. 5

1.3 The Conceptual Framework for Financial Reporting ..................................12

1.4 Preface to International Financial Reporting Standards ............................22

TOAMOD1.1 OVERVIEW OF ACCOUNTING

Definition of Accounting
Accounting is the process of identifying, measuring, and communicating economic information to permit
informed judgment and decisions by users of information.
IDENTIFYING MEASURING COMMUNICATING
Identifying is the process of Measuring is the process of Communicating is the process of
analyzing events and transactions assigning numbers, normally in transforming economic data into
to determine whether or not they monetary terms, to the economic useful accounting information
will be recognized in the books. transactions and events. such as financial statements and
other accounting reports for
Accountable events – recognized Measurement bases: dissemination to users.
in the books through a journal From the Conceptual Framework:
entry made in the books. 1. Historical cost Aspects of the communication
2. Current cost process:
Non-accountable events – not 3. Realizable (settlement) value 1. Recording
recognized but disclosed in the 4. Present value 2. Classifying
notes to financial statements or From the Standards: 3. Summarizing
recorded through a 5. Fair value
memorandum entry when such 6. Fair value less costs to sell Interpreting processed
events have accounting 7. Revalued amount information involves the
relevance. 8. Inflation-adjusted costs computation of financial
statement ratios.
Types of events or transactions: Valuation by fact – items
1. External events measured are unaffected by NOTE: Bookkeeping refers to the
a. Exchange estimates. process of recording the accounts
b. Non-reciprocal transfer or transactions of an entity.
c. Other than transfer Valuation by opinion – items Unlike accounting, it does not
2. Internal events measured are affected by require interpretation of the
a. Production estimates. significance of processed
b. Casualty information.

Basic Purpose of Accounting

The basic purpose of accounting is to provide quantitative financial information about economic activities
intended to be useful in making economic decisions.
Economic entities use accounting Types of information provided by Types of accounting information
to record economic activities, accounting: classified as to users’ needs:
process data, and disseminate 1. Quantitative information – 1. General purpose – designed to
information intended to be useful expressed in numbers, quantities meet the common needs of most
in making economic decisions. or units. financial statement users. It is
2. Qualitative information – governed by GAAP represented
Economic entity – separately expressed in words or descriptive by the IFRSs.
identifiable combination of form. 2. Special purpose – designed to
persons and property that uses or 3. Financial information – meet the specific needs of
controls economic resources to expressed in money. It is also particular financial statement
achieve certain goals or considered a quantitative users. This is provided by other
objectives. Either not-for-profit information. types of accounting other than
or business. financial accounting.
NOTE: To be useful, accounting
Economic activity – affects the information should be stated in a Sources of information in
economic resources and common denominator. For financial statements:
obligations, and consequently, the example, currencies denominated Not obtained exclusively from the
equity of an economic entity. in foreign currencies should be entity’s accounting records. Some
Includes production, exchange, translated to the presentation are obtained from external
consumption, income currency. sources.
distribution, savings and
investment.

Common Branches of Accounting

1. Financial accounting – focuses on general purpose reports of financial position and operating
results known as financial statements.
2. Management accounting – accumulation and communication of information for use by internal
parties or management.
3. Cost accounting – systematic recording and analysis of the costs of materials, labor and overhead
incident to production.

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 1

 4. Auditing – a systematic process of objectively obtaining and evaluating evidence regarding
assertions about economic actions and events to ascertain the degree of correspondence between
these assertions and established criteria and communicating the results to interested users.
5. Tax accounting – preparation of tax returns and rendering of tax advice, such as determination of
tax consequences of certain proposed business endeavors.
6. Government accounting – accounting for the national government and its instrumentalities,
focusing attention on the custody of public funds and the purpose or purposes to which such funds
are committed.
7. Fiduciary accounting – handling of accounts managed by a person entrusted with the custody and
management of property for the benefit of another.
8. Estate accounting – handling of accounts for fiduciaries who wind up the affairs of a deceased
person.
9. Social accounting – process of communicating the social and environmental effects of
organizations’ economic actions to particular interest groups within society and to society at large.
10. Institutional accounting – accounting for not-for-profit entities other than the government.
11. Accounting systems – installation of accounting procedures for the accumulation of financial data
and designing of accounting forms to be used in data gathering.

Accounting assumptions are the fundamental concepts or principles and basic notions that provide the
foundation of the accounting process.
I. Underlying assumptions – explicitly provided in the Conceptual Framework
1. Going concern assumption – entity is assumed to carry on its operations for an indefinite period
of time

II. Implicit assumptions – not expressly provided in the Conceptual Framework

1. Separate entity – entity is treated separately from its owners
2. Stable monetary unit – items should be stated in terms of a unit of measure (pesos in the
Philippines) and its purchasing power is regarded as stable or constant
3. Time Period – life of the business is divided into series of reporting periods

III. Pervasive – affects all items in the financial statements

1. Materiality concept – information is material if its omission or misstatement could influence
economic decisions, a matter of professional judgment based on information’s size and nature
2. Cost-benefit – cost of processing and communicating information should not exceed the benefits
to be derived from it

IV. Other concepts

1. Accrual basis of accounting – effects of transactions and events are recognized when they occur
2. Concept of articulation – all the components of a complete set of financial statements are
interrelated
3. Full disclosure principle – the nature and amount of information included in financial reports
reflect a series of judgmental trade-offs (sufficient detail vs. sufficient condensation)
4. Consistency concept – financial statements should be prepared on the basis of accounting
principles which are followed consistently from one period to the next
5. Matching – costs are recognized as expenses when the related revenue is recognized
6. Entity theory – accounting objective is geared towards proper income determination (A = L + C)
7. Proprietary theory – accounting objective is geared toward proper valuation of assets (A – L = C)
8. Residual equity theory – applicable where there are two classes of shares issued, ordinary and
preferred (A – L – PSHE = OSHE)
9. Fund theory – accounting objective is neither proper income determination nor proper valuation
of assets but the custody and administration of funds (Cash inflows – Cash outflows = Fund)
10. Realization – process of converting non-cash assets into cash or claims to cash
11. Prudence or Conservatism – inclusion of a degree of caution in the exercise of the judgments
needed in making the estimates required under conditions of uncertainty, such that assets or
income are not overstated and liabilities or expenses are not understated (least effect on equity)

Accountancy refers to the profession or practice of accounting. The practice of accounting can be broadly
subdivided into two – public practice and private practice.
Practice of Public Practice in Commerce Practice in Practice in the
Accountancy and Industry Education/Academe Government
Involves the rendering Refers to employment in Employment in an Employment or
of audit or accounting the private sector in a educational institution appointment to a
related services to more position which involves which involves teaching position in an
than one client on a fee decision making of accounting, auditing, accounting professional
basis. requiring professional management advisory group in government or
knowledge in the services, finance, in a GOCC
science of accounting. business law, taxation.

2 TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS

Accounting standards Accounting standard setting bodies and other
The Generally Accepted Accounting Principles relevant organizations
(GAAP) in the Philippines are represented by the
Philippine Financial Reporting Standards (PFRSs).
PFRSs are Standards and Interpretations adopted by 1. Financial Reporting Standards Council (FRSC)
the Financial Reporting Standards Council (FRSC). - formerly known as Accounting Standards
They comprise: Council (ASC), the official accounting standard
a. Philippine Financial Reporting Standards setting body in the Philippines created under RA
b. Philippine Accounting Standards 9298 by the PRC upon recommendation of BOA
c. Interpretations - composed of 15 individuals – 1 chairperson and
14 members
PFRSs are accompanied by guidance to assist 2. Philippine Interpretations Committee (PIC)
entities in applying their requirements. Guidance - committee formed by the ASC, the predecessor
that is an integral part of the PFRSs is mandatory of FRSC, with the role of reviewing interpretations
while guidance that is not an integral part of the prepared by IFRIC for approval and adoption of
PFRSs does not contain requirements for financial FRSC
statements. 3. Board of Accountancy (BOA)
- professional regulatory board created under RA
Hierarchy of Reporting Standards 9298 to supervise the registration, licensure and
1. PFRSs practice of accountancy in the Philippines
2. In the absence of a Standard or - composed of a chairperson and 6 members
Interpretation that specifically applies to a appointed by the President of the Philippines
transaction, management must use its 4. Securities and Exchange Commission (SEC)
judgment in developing and applying an 5. International Organization of Securities
accounting policy that results in Commission (IOSCO)
information that is relevant and reliable 6. Bureau of Internal Revenue (BIR)
a. Requirements and guidance in 7. Bangko Sentral ng Pilipinas (BSP)
PFRSs dealing with similar and 8. Cooperative Development Authority (CDA)
related issues
b. Conceptual Framework NOTE: Financial reporting standards continuously
c. Most recent pronouncements of change primarily in response to users’ needs.
other standard-setting bodies Changes in financial reporting standards are also
d. Other accounting literature and influenced by legal, political, business and social
accepted industry practices environments.

International Accounting Standards

1. International Accounting Standards Board (IASB) – established in April 2001 as part of the
International Accounting Standards Committee (IASC) Foundation with the responsibility of approving
IFRSs and related documents, such as the Conceptual Framework, exposure drafts and other discussion
documents. The financial reporting standards in the Philippines are adopted from the IASB standards.

NOTE: IFRSs are standards issued by the IASB while IASs are standards issued by the IASC which were
adopted by the IASB.

2. International Financial Reporting Interpretations Committee (IFRIC) – a committee that prepares

interpretations of how specific issues should be accounted for under the application of IFRS where (1) the
standards do not include specific authoritative guidance and (2) there is a risk of divergent and
unacceptable accounting practices. In 2002, IFRIC replaced the former Standing Interpretations Committee
(SIC) which had been created by the IASC.

3. Standards Advisory Council (SAC) – group of organizations and individuals with an interest in
international financial reporting, a body set up to participate in the standard-setting process. Members are
appointed by the IASC Foundation.

4. International Federation of Accountants (IFAC) – a non-profit, non-governmental, non-political

organization of accountancy bodies that represents the worldwide accountancy profession.

Move to IFRSs
Prior to full adoption of the IFRSs in 2005, GAAP in the Philippines were previously based on the
Statements of Financial Accounting Standards (SFAS) issued by Federal Accounting Standards Board
(FASB). The move to IFRSs was primarily brought about by the increasing acceptance of IFRSs worldwide
and increasing internationalization of businesses thereby increasing the need for a common financial
reporting standards that minimizes, if not eliminate, inconsistencies of financial reporting among nations.

The future of IFRSs

In October 2002, FASB and IASB entered into a Memorandum of Understanding (the Norwalk
Agreement), whereby they formalized their commitment to the convergence of US GAAP and IFRSs.

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 3

TOAMOD1.2 THE ACCOUNTING PROCESS

Accounting process comprises the activities of identifying, measuring and communicating economic
information that is useful for decision making purposes.
Accounting information system (accounting Management information system is a set of data
system) is the system of collecting and processing gathering, analyzing and reporting functions
transaction data and disseminating financial designed to provide management with the
information to interested parties. It is a subsystem information it needs to carry out its functions.
of MIS. Components are: Components are:
a. Personnel a. Accounting Information System
b. Relevant accounting policies and standards b. Personnel Information System
c. Procedures c. Logistics Information System
d. Equipment and devices
e. Records and reports

Accounting cycle represents the steps or accounting procedures normally used by entities to record
transactions and prepare financial statements. It implements the accounting process.
1. Identifying and analyzing
The accountant gathers information from source documents and determines the impact of the transactions
on the financial position as represented by the basic equation A = L + E.

Accounting records: (1) Source documents, (2) Books of original entry, (3) Books of final entry

Systems of recording transactions: (1) Double-entry system, (2) Single-entry system

2. Journalizing
The process of recording transactions in the journal by means of journal entries.

Journal – a formal record where transactions are initially recorded chronologically through journal entries.
a. General journal – used to record transactions other than those recorded in special journals
b. Special journal – used to record transactions of a similar nature (e.g. Sales journal, Purchase
journal, Cash receipts book, Cash disbursements book)

Type of journal entries:

a. Simple journal entry – single debit and single credit
b. Compound journal entry – two or more debits or credits
c. Adjusting entries – made prior to the preparation of financial statements to update certain
accounts so that they reflect correct balances as at the designated time
d. Closing entries – made at the end of the accounting period after all adjustments have been made to
zero-out the balances of nominal accounts and to update the retained earnings account
e. Reversing entries – entries usually made in the next accounting period to reverse certain adjusting
entries made in the previous accounting period in order to facilitate recording of cash receipts and
disbursements in the next accounting period
f. Correcting entries – made to correct accounting errors committed
g. Reclassification entries – made to transfer an item from one account to another account that better
describes the nature of the item transferred
3. Posting
The process of transferring data from the journal to the appropriate accounts in the ledger. It serves to
classify the effects of transactions on specific asset, liability, equity, income and expense accounts.

Ledger – systematic compilation of a group of accounts.

Kinds of ledger:
a. General ledger – contains all accounts appearing in the financial statements
b. Subsidiary ledger – a supporting ledger consisting of a group of accounts with similar nature, the
total of which is in agreement with the balance of the related controlling account in the general
ledger

Account is the basic storage of information in accounting. Accounts in the ledger follow the format of a T-
account, wherein the left side is called debit and the right side is called credit. Chart of accounts is a list of
all the accounts used by the entity.
a. Real or permanent accounts – not closed at the end of the accounting period
b. Nominal or temporary accounts – closed at the end of the accounting period
c. Mixed accounts – having both statement of financial position and income statement components
d. Contra accounts – offset accounts or accounts which are deducted from the related account
e. Adjunct account – accounts which are added to the related account

4 TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS

4. Unadjusted trial balance (optional)
An internal control as adjusting entries and consequently, financial statements, cannot be prepared unless
the total debits and credits agree.

Trial balance – list of accounts with their balances prepared for the purpose of proving the mathematical
accuracy of the monetary totals of debits and credits in the ledger.
a. Unadjusted trial balance – prepared before the preparation of adjusting entries, contains real,
nominal, and mixed accounts
b. Adjusted trial balance – prepared after the adjusting entries, contains real and nominal accounts
c. Post-closing trial balance – prepared after the closing process, contains real accounts only

Errors revealed by a trial balance:

a. Journalizing or posting one-half of an entry (a debit without credit or vice versa)
b. Recording one part of an entry for a different amount than the other part
c. Errors of transplacement (slide error) on one side of an entry
d. Errors of transposition on one side of an entry

Errors not revealed by a trial balance:

a. Omitting entirely the entry for a transaction
b. Journalizing or posting an entry twice
c. Using wrong account with the same normal balance as the correct account
d. Wrong computation with same erroneous amounts posted to debit and credit sides
5. Adjusting entries
These are made prior to the preparation of the financial statements to update certain asset, liability,
income or expense accounts in order to bring them to their adjusted balances. Involve at least one
statement of financial position account and one statement of profit or loss and other comprehensive
account. All adjusting entries affect the comprehensive income for the period.
a. Accrued expense – expense incurred but not yet paid
b. Accrued income – income earned but not yet received or collected
c. Prepaid expense – expense paid or acquired in advance
d. Unearned income – income already collected but not yet earned
e. Depreciation – systematic allocation of the depreciable amount of an item of property, plant and
equipment over its useful life
f. Uncollectible accounts – customers’ accounts that may no longer be collected or that may possibly
become bad debts
6. Adjusted trial balance (optional)
Worksheet – an analytical device used in accounting to facilitate the gathering of data for adjustments, the
preparation of financial statements, and closing entries. This is optional but usually prepared in practice
using spreadsheet application.
7. Financial statements
These are the means by which the information accumulated and processed in financial accounting is
periodically communicated to the users. These are the end products of the accounting process.
(See Module 2 for a more in-depth discussion)
8. Closing the books
This is the process of preparing closing entries for nominal accounts and ruling and balancing real
accounts. This is an application of the periodicity concept.

Closing entries – prepared at the end of accounting period to “zero out” all temporary or nominal accounts
in the ledger. This is done so that the transactions in a period will not co-mingle with the next period’s
transactions.
9. Post-closing trial balance (optional)
This is prepared after closing the books and contains only statement of financial position accounts since all
income statement accounts would have been closed. This serves as an internal control to ensure the
equality of the debits and credits in the ledger after the closing process.
10. Reversing entries (optional)
Reversing entries – usually made (but not always) on the first day of the next accounting period to reverse
certain adjusting entries made in the immediately preceding period.

Purposes:
a. To facilitate recording of cash receipts and disbursements in the next accounting period
b. For convenience in recording next period’s year-end adjustments for accruals
c. For consistency of accounting procedures

What may be reversed?

a. All accruals, whether for income or expense
b. Prepayments initially recorded using the expense method
c. Unearned income initially recorded using the income method

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 5

TOAMOD1.3 THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING
History of the Framework
Framework for the Preparation and Presentation of Financial Statements (the
1989 April
Framework) was approved by the IASC Board.
1989 July Framework was published.
2001 April Framework adopted by the IASB.
Conceptual Framework for Financial Reporting 2010 (the IFRS Framework) approved
2010 September
by the IASB.

Introduction
A conceptual framework is a coherent system of interrelated basic concepts and propositions that
prescribe objectives, limits, and other fundamentals of financial accounting and serves as a basis for
developing and evaluating accounting principles and resolving accounting and reporting controversies.
Purpose: Authoritative status:
a. Assist the FRSC in developing accounting standards that 1. The Conceptual Framework is not a
represent generally accepted accounting principles in the PFRS and hence does not define
Philippines. standards for any particular
b. Assist the FRSC in its review and adoption of existing measurement or disclosure issue.
international financial reporting standards. 2. In the Conceptual Framework,
c. Assist preparers of financial statements in applying FRSC nothing overrides any specific PFRS.
financial reporting standards and in dealing with topics that 3. If there is a conflict between a
have yet to form the subject of an FRSC statement. requirement of a PFRS and a provision
d. Assist auditors in forming an opinion as to whether financial of the Conceptual Framework, the
statements conform with Philippine generally accepted requirement of the PFRS will prevail.
accounting principles. 4. Hierarchy of guidance:
e. Assist users of financial statements in interpreting the a. PFRSs
information contained in financial statements prepared in b. Similar and related PFRSs
conformity with Philippine generally accepted accounting c. Conceptual Framework
principles. d. Most recent pronouncements of
f. Provide those who are interested in the work of FRSC with other standard-setting bodies
information about its approach to the formation of financial e. Other accounting literature and
reporting standards. accepted industry practices

Scope of the Framework

The framework deals with:
a. The objective of financial reporting
b. The qualitative characteristics of useful information
c. The definition, recognition and measurement of the elements from which financial statements are
constructed
d. Concepts of capital and capital maintenance
Objective of financial reporting
The objective of general purpose financial reporting 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.

Primary users – cannot require reporting entities to provide information directly to them
a. Existing and potential investors
b. Lenders and other creditors

The Framework notes that general purpose financial reports cannot provide all the information that users
may need to make economic decisions. They will need to consider pertinent information from other
sources as well.

Information on economic resources, claims and changes in them

a. Financial position – information on economic resources (assets) and claims against the
reporting entity (liabilities and equity). Assists users to
i. assess that entity's financial strengths and weaknesses
ii. assess liquidity and solvency
iii. assess its need and ability to obtain financing
iv. predict how future cash flows will be distributed among those with a claim on the reporting
entity (information about claims and payment requirements)
b. Changes in economic resources and claims – information on financial performance and other
transactions and events that lead to changes in financial position
i. Financial performance reflected by accrual accounting (statement of comprehensive income)
ii. Financial performance reflected by past cash flows (statement of cash flows)

6 TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS

 iii. Changes in economic resources and claims not resulting from financial performance
(statement of changes in equity)

NOTE: To assess future cash flows, all information regarding an entity’s financial position, financial
performance, cash flows, and other changes in financial position must be considered.
Qualitative characteristics of useful information
These identify the types of information that are likely to be most useful to the primary users for making
decisions about the reporting entity on the basis of information in its financial report.
a. Fundamental (Relevance, Faithful representation)
b. Enhancing (Comparability, Verifiability, Timeliness, Understandability)

Fundamental qualitative characteristics

1. Relevance – capability of making a difference in the decisions made by users. Ingredients are:
a. Predictive value – can be used as an input in predicting or forecasting future outcomes.
b. Confirmatory (feedback) value –provides feedback about previous evaluations.
c. Materiality – its omission or misstatement could influence decisions that users make. It is an
entity-specific aspect of relevance based on the nature or magnitude (or both) of the items to which
the information relates in the context of an individual entity's financial report.

2. Faithful representation – financial reports represent economic phenomena in words and in numbers that
it purports to represent. Ingredients are:
a. Completeness – all information necessary for the understanding of the phenomenon being
depicted shall be provided.
b. Neutrality – financial information are selected or presented without bias.
c. Free from error – does not mean accurate in all respects, there are no errors or omissions in the
description of the phenomenon and the process used to produce the reported information has been
selected and applied with no errors in the process.

NOTE: Information must be both relevant and faithfully represented if it is to be useful.

Enhancing qualitative characteristics

1. Comparability – can be compared with similar information about other entities (inter-comparability)
and with similar information about the same entity for another period or another date (intra-
comparability). It enables users to identify and understand similarities in, and differences among, items.

2. Verifiability - different knowledgeable and independent observers could reach consensus, although not
necessarily complete agreement, that a particular depiction is a faithful representation. Verification can be
done through direct observation (direct) or checking inputs to a model, formula and other technique and
recalculating the outputs using the same methodology (indirect).

3. Timeliness - information is available to decision-makers in time to be capable of influencing their

decisions.

4. Understandability – information is classified, characterized and presented clearly and concisely. While
some phenomena are inherently complex and cannot be made easy to understand, to exclude such
information would make financial reports incomplete and potentially misleading. Financial reports are
prepared for users who have a reasonable knowledge of business and economic activities and who
review and analyze the information with diligence.

NOTE: Enhancing qualitative characteristics should be maximized to the extent necessary. However,
enhancing qualitative characteristics (either individually or collectively) cannot make information useful if
that information is irrelevant or not represented faithfully.

The cost constraint on useful financial reporting

Cost is a pervasive constraint on the information that can be provided by general purpose financial
reporting. Reporting such information imposes costs and those costs should be justified by the benefits
of reporting that information. The IASB assesses costs and benefits in relation to financial reporting
generally, and not solely in relation to individual reporting entities. The IASB will consider whether
different sizes of entities and other factors justify different reporting requirements in certain situations.

Underlying assumption
The IFRS Framework states that the going concern assumption is an underlying assumption. Thus, the
financial statements presume that an entity will continue in operation indefinitely or, if that presumption is
not valid, disclosure and a different basis of reporting are required.
Elements of financial statements

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 7

1. Elements directly related to financial position (balance sheet):
a. Asset - a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity.
b. Liability - a present obligation of the entity arising from past events, the settlement of which is
expected to result in an outflow from the entity of resources embodying economic benefits.
c. Equity - the residual interest in the assets of the entity after deducting all its liabilities.

2. Elements directly related to performance (income statement):

a. Income - increases in economic benefits during the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities that result in increases in equity, other than those
relating to contributions from equity participants.
i. Revenue – arises in the course of the ordinary activities of an entity and is referred to by a
variety of different names including sales, fees, interest, dividends, royalties and rent.
ii. Gain – other items that meet the definition of income and may, or may not, arise in the course
of the ordinary activities of an entity.
b. Expense - decreases in economic benefits during the accounting period in the form of outflows or
depletions of assets or incurrences of liabilities that result in decreases in equity, other than those
relating to distributions to equity participants.
i. Expense – arise in the course of the ordinary activities of the entity include, for example, cost
of sales, wages and depreciation.
ii. Loss – other items that meet the definition of expenses and may, or may not, arise in the
course of the ordinary activities of the entity.

Recognition of the elements of financial statements

Recognition is the process of incorporating in the balance sheet or income statement an item that meets
the definition of an element and satisfies the following criteria for recognition:
a. It is probable that any future economic benefit associated with the item will flow to or from the
entity; and
b. The item's cost or value can be measured with reliability

Based on these general criteria:

1. An asset is recognized in the balance sheet when it is probable that the future economic benefits will
flow to the entity and the asset has a cost or value that can be measured reliably.
2. A liability is recognized in the balance sheet when it is probable that an outflow of resources
embodying economic benefits will result from the settlement of a present obligation and the amount at
which the settlement will take place can be measured reliably.
3. Income is recognized in the income statement when an increase in future economic benefits related to
an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means,
in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or
decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or
the decrease in liabilities arising from the waiver of a debt payable).
4. Expenses are recognized when a decrease in future economic benefits related to a decrease in an asset
or an increase of a liability has arisen that can be measured reliably. This means, in effect, that
recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a
decrease in assets (for example, the accrual of employee entitlements or the depreciation of equipment).
a. Direct association - costs are recognized as expenses when the related revenue is recognized
b. Systematic and rational allocation – applied when economic benefits are expected to arise over
several accounting periods
c. Immediate recognition

Measurement of the elements of financial statements

Measurement involves assigning monetary amounts at which the elements of the financial statements are
to be recognized and reported. (historical cost, current cost, realizable (settlement) value, present value)

NOTE: Historical cost is the measurement basis most commonly used today, but it is usually combined
with other measurement bases. The IFRS Framework does not include concepts or principles for
selecting which measurement basis should be used for particular elements of financial statements or in
particular circumstances. Individual standards and interpretations do provide this guidance,
however.
Concepts of capital and capital maintenance
1. Concepts of capital
a. Financial concept of capital – capital is synonymous with the net assets or equity of the entity.
b. Physical concept of capital – capital is regarded as the productive capacity of the entity based on,
for example, units of output per day.

2. Concepts of capital maintenance

8 TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS

 a. Financial capital maintenance – a profit is earned only if the financial (or money) amount of the
net assets at the end of the period exceeds the financial (or money) amount of the net assets at the
beginning of the period, after excluding any distributions to, and contributions from, owners during
the period. Does not require the use of a particular basis of measurement.
b. Physical capital maintenance – a profit is earned only if the physical productive capacity (or
operating capability) of the entity (or the resources or funds needed to achieve that capacity) at the
end of the period exceeds the physical productive capacity at the beginning of the period, after
excluding any distributions to, and contributions from, owners during the period. Requires the
adoption of the current cost basis of measurement.

NOTE: The principal difference between the two concepts of capital maintenance is the treatment of the
effects of changes in the prices of assets and liabilities of the entity.

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 9

TOAMOD1.4 PREFACE TO INTERNATIONAL FINANCIAL REPORTING STANDARDS
History of the Preface to International Financial Reporting Standards
1975 January Preface to International Accounting Standards adopted by IASC
1982 November Preface to International Accounting Standards amended by IASC
2001 July Project to replace the old Preface with a new one was placed on IASB agenda
2001 July Exposure Draft of Preface to International Financial Reporting Standards published
by IASB
2002 May Final Preface to International Financial Reporting Standards published by IASB
2007 December Amendments to Preface approved by the IASB reflecting increase in size of IFRIC to
14 members

Objective of the Preface to IFRS

The objective of the Preface to International Financial Reporting Standards is to set out:
a. the International Accounting Standards Board's (IASB's) mission and objectives
b. the scope of International Financial Reporting Standards (IFRSs)
c. due process for developing IFRSs and Interpretations
d. policies on effective dates, format, and language for IFRSs
Objectives of the IASB
a. to develop, in the public interest, a single set of high quality, understandable, enforceable and
globally accepted financial reporting standards based upon clearly articulated principles. These
standards should require high quality, transparent and comparable information in financial
statements and other financial reporting to help investors, other participants in the world’s capital
markets and other users of financial information make economic decisions;
b. to promote the use and rigorous application of those standards;
c. in fulfilling the objectives associated with (a) and (b), to take account of, as appropriate, the needs
of a range of sizes and types of entities in diverse economic settings; and
d. to promote and facilitate adoption of IFRSs, being the standards and interpretations issued by the
IASB, through the convergence of national accounting standards and IFRSs.
Scope of IFRSs
 IASB Standards are known as International Financial Reporting Standards.
 All International Accounting Standards (IASs) and Interpretations issued by the former IASC and SIC
continue to be applicable unless and until they are amended or withdrawn.
 IFRSs apply to the general purpose financial statements and other financial reporting by profit-
oriented entities – those engaged in commercial, industrial, financial, and similar activities, regardless of
their legal form.
 Entities other than profit-oriented business entities may also find IFRSs appropriate.
 General purpose financial statements are intended to meet the common needs of shareholders,
creditors, employees, and the public at large for information about an entity's financial position,
performance, and cash flows.
 Other financial reporting includes information provided outside financial statements that assists in the
interpretation of a complete set of financial statements or improves users' ability to make efficient
economic decisions.
 IFRS apply to individual company and consolidated financial statements.
 A complete set of financial statements includes:
a. a statement of financial position
b. a statement of comprehensive income
c. a statement of cash flows
d. a statement of changes in equity
e. a summary of accounting policies, and explanatory notes
 When a separate income statement is presented in accordance with IAS 1(2007), it is part of that
complete set.
 In developing Standards, IASB intends not to permit choices in accounting treatment. Further, IASB
intends to reconsider the choices in existing IASs with a view to reducing the number of those choices.
 IFRS will present fundamental principles in bold face type and other guidance in non-bold type (the
'black-letter'/'grey-letter' distinction). Paragraphs of both types have equal authority.
 The provision of IAS 1 Presentation of Financial Statements that conformity with IAS requires compliance
with every applicable IAS and Interpretation requires compliance with all IFRSs as well.
Due process for IFRS
 Due process steps for a Standard will normally include the following: (* means required by IFRS
Foundation’s Constitution)
a. staff work to identify and study the issues
b. study of existing national standards and practices
c. IASB consults with Trustees and the Advisory Council about the advisability of adding the project to
the IASB's agenda*
d. IASB normally forms an advisory group

10 TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS

 e. IASB publishes a discussion document for comment
f. IASB considers comments received on the discussion document
g. IASB publishes an exposure draft with at least 9 affirmative votes if there are fewer than 16
members, or 10 if there are 16 members* (the exposure draft will include dissenting opinions and
basis for conclusions)
h. IASB considers comments received on the exposure draft*
i. IASB considers the desirability of holding a public hearing and of conducting field tests*
j. IASB approves the final Standard with at least 9 affirmative votes if there are fewer than 16
members, or 10 if there are 16 members* (the Standard will include dissenting opinions and basis
for conclusions)
k. IASB publishes a standard with (i) a basis for conclusions, explaining, among other things, the steps
in the IASB's due process and how the IASB dealt with public comments on the exposure draft, and
(ii) the dissenting opinion of any IASB member*
 IASB deliberates in meetings open to public observation

Due process for Interpretations

 Interpretations of IFRS will be developed by the IFRS Interpretations Committee for approval by IASB
 Due process steps for an Interpretation will normally include: (* means required by IFRS Foundation's
Constitution)
a. staff work to identify and study the issues and existing national standards and practices
b. The IFRS Interpretations Committee studies national standards and practices
c. The IFRS Interpretations Committee publishes a draft Interpretation for comment if no more than 4
Committee members have voted against the proposal*
d. The IFRS Interpretations Committee considers comments received on the draft Interpretation
within a reasonable period of time
e. The IFRS Interpretations Committee approves the final Interpretation if no more than 4
Interpretations Committee members have voted against the proposal and submits it to IASB*
f. IASB approves the final Interpretation by at least 9 affirmative votes of IASB if there are fewer than
16 members, or by 10 of its members if there are 16 members*
 The IFRS Interpretations Committee deliberates in meetings open to public observation
Effective dates
Each IFRS and Interpretation will set out its own effective date and transition provisions. New or revised
IFRSs set out transitional provisions to be applied on their initial application.

Language
English is the official language of IASB discussion documents, exposure drafts, IFRSs, and Interpretations.
IASB may approve translations if the process assures the quality of the translation, and IASB may license
other translations.

TOAMOD1 OVERVIEW OF ACCOUNTING AND INTRODUCTION TO IFRS 11