CHAPTER 1: The Nature of Accounting and Its Business Environment

LESSON 1-1 THE NATURE OFACCOUNTING

Lesson objectives
 define accounting
 describe its nature and function in business

WHAT IS ACCOUNTING?
Accounting is the systematic process of measuring and reporting relevant financial information
about the activities of an economic organization or unit. Its underlying purpose is to provide financial
information. It is capable of being expressed in monetary terms.
The American Institute of Certified Public Accountants (AICPA) defines accounting as the art of
recording, classifying, and summarizing in a significant manner and in terms of money, transaction, and
events, which are in part at least of a financial character, and interpreting the result thereof.
The Philippine Institute of Certified Public Accountants (PICPA) defines accounting as a service
activity. Its function is to provide quantitative information, primarily financial in nature, about economic
entities, that is intended to be useful in making economic decisions.

Nature of Accounting
The nature of accounting is in its definition as follows:
1. Accounting is a systematic process.
 Process is a series of actions that produce something or that lead to a particular result. As such,
the performance of the four aspects of accounting, which are recording, classifying,
summarizing, and interpreting, leads to communicating to its users the relevant financial
information needed by the parties interested.
2. Accounting is an art.
 Art is a skill acquired by experience, study, or observation. It is also defined as an occupation
requiring knowledge or skill. The four aspects of accounting require both knowledge and skill
through experience, study, or observation as a means to produce the key end product which are
the financial reports.
3. Accounting is a service activity.
 Service is the occupation or function of serving. Activity is something that is done as work or for a
particular purpose. Combining the meaning of the two words. Accounting is a work or occupation
for serving a particular purpose. Hence, since its purpose is to provide financial information, the
data that it will process in terms of the four aspects of accounting should be expressed in monetary
terms. In short, it is interested in activities that can be measured and expressed in terms of the
value of money.

Four Aspects of Accounting

1. Recording — writing down of business transactions chronologically in the books of account as they
transpire
2. Classifying—sorting similar and related business transactions into the three categories of assets,
liabilities, and owner's equity
3. Summarizing — preparing the financial statements from the transactions recorded in the books of
account that are designed to meet the information needs of its users
4. Interpreting — representing the qualitative and quantitative financial information about the
business transactions in a language comprehensible to the users of financial statements. BV interpreting the
data in the financial statements, users are able to determine the financial standing of the company as well as
its stability and growth potential. Users interpret financial information relating to specific business
decisions. This makes accounting the language of business.

The Basic Function of Accounting in Business

The aspects of accounting can be summed up to one basic function, which is the generation of
relevant and timely financial information for interested parties. The data provided by accountants can
assist investors, government agencies, creditors, and management in making sound decisions. The
financial information provided about the activities of an economic organization makes it easily
comprehensible for users to assess its financial position as of a given time and results of operations for a
given period. This qualitative and quantitative financial data used by users relating to specific business
decisions makes accounting the language of business.

LESSON 1-2 HISTORY OF ACCOUNTING

Lesson objective
 know the origin and history of accounting

A BRIEF HISTORY OF ACCOUNTING

"It is believed that the very origins of writing itself may have developed out of early marks used to keep
account of goods at ancient warehouses more than 5,300 years ago. The notion that pre-numerical counting
systems pre-dated even written language didn't come as a surprise to many historians and archaeologists
who have long since recognized that the history of human civilization is largely indistinguishable from the
history of commerce.”
Ancient Accounting in Egypt, Mesopotamia, Greece, and Rome

The history of accounting dates back to ancient times. The abacus which functioned as a calculator
in the ancient times, was developed by the Sumerians in 5,000
BCE followed by the papyrus which was developed by ancient Egyptians in 4,000 BCE.
The papyrus not only allowed recording of commercial transactions but also the transcription of religious
text, music, literature, and more. In Egypt, archaeologist Dr. Gunter Dreyer Of the German Institute of
Archaeology unearthed clay tablets considered to be among the oldest written tax accounting records. In
the tomb of King Scorpion I in Egypt, he discovered old stone labels believed to date back to 3,000 BCE
or around 5,300 years ago. These old stone labels were complete with marks representing accounts of oil
and linens which were believed to be paid to the king as taxes.

Mesopotamia had clay tokens and clay tablets to record their loans, herds, crops, and system of trade.
The scribes who performed extensive duties in writing and recording in the Mesopotamian civilization are
the equivalent of present-day accountants. Aside from writing down commercial transactions, scribes
assured that the agreements were in compliance with the detailed code requirements for commercial
transactions.

The Greeks also made significant contributions to the development of accounting. In 600 BCE, they
introduced money in the form of coins. Moreover, they adopted the Phoenician writing system and invented
the Greek alphabet which they used to facilitate record-keeping. As early ng those times, bankers in Greece
offered credit and helped people transfer funds to banks in other cities as evidenced by the bankers' book of
account. It was the same in Rome where accounting helped establish their finance and legal system. In fact,
the Romans introduced the use of an annual budget which coordinated estimated revenues and taxes paid by
the citizen in relation to the nation’s expenditures. A cash book was maintained by households for their
expenses.

In England, William the Conqueror took possession of all properties in the name of the king upon his
invasion. In 1086, the Domesday Book contained all the real estate surveyed by William the Conqueror and
the taxes due to them. To date, the Pipe Roll or the Great Roll of the Exchequer is the most ancient
surviving accounting record in the English language. This contains the yearly accounting of rents, fines, and
taxes due to the King of England, from 1130 to 1830.

14th Century — The Birth of Double-Entry Bookkeeping

During the 14th century, Luca Pacioli of Italy, otherwise known as Friar Luca dal Borgo, a
mathematician, friend and contemporary of Leonardo da Vinci, and considered to be the "Father of
Accounting' wrote Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything About
Arithmetic, Geometry and Proportion). One section of this book, De Computis et Scripturis (Of Reckonings
and Writings), is composed of 36 short chapters that describe bookkeeping. The accounting cycle, similar to
the modern day accounting cycle is also included in this book. The book also explains the extensively used
balance sheet of today, the method of using memorandums, journals and ledgers, the use of accounts such as
assets, liabilities, owner's equity, revenue and expenses, year-end closing entries, and the use of the trial
balance to prove a balanced ledger.

Pacioli credited Benedetto Cotrugli, for the original idea of the double-entry bookkeeping. Cotrugli's
manuscript of Della Mercatura et del Mercante Perfetto (of Trading and The Perfect Trader), which
contains a brief description of the double-entry of bookkeeping, was never printed. Actually, not only Luca
Pacioli, but the Italians are broadly recognized to be the father of accounting for their marked contribution to
the improvement of trade and commerce. The business-minded early capitalistic Venetian merchants used
double-entry system of recording in the late 15th century to calculate their earnings and profits.
19th Century — The Dawn of Modern Accounting in Europe and
America
Domination of the Theories of accounts (rather than accounting theories) marked not only the
beginning but also the latter part of the nineteenth century. In England, the Industrial Revolution which
replaced hand tools with machine or power tools, otherwise known as the factory system, transformed
accounting into an actual profession. Businesses continued to expand requiring the expertise of accountants
to gain corporate control of their flourishing business.

In Scotland, Queen Victoria granted n royal charter to the Institute of Accountants in Glasgow on
July 6, 1854, thereby creating the profession of chartered accountant (CA). Thus, accounting became
formal profession. In the latter part of the 19th century, because large amounts of British capital were
invested in flourishing industries in the United States, Scottish or British chartered accountants were
sent to the United States to audit British investments. Some of these accountants decided to stay in
America and became provenances of various accounting firms, which they set up to practice their
profession. The year 1887 saw the birth of the first national US accounting society. The American
Association of Public Accountants which provided formal certification process for accountants was the
predecessor of the present American Institute of Certified Public Accountants (AICPA).

20th Century — The Evolution of Modern Accounting Standards

The American Institute of Certified Public Accountants (AICPA), the first national professional
association for Certified Public Accountants (CPA), was formed in the young but prosperous nation of the
United States. Because of the economic depression, the Securities and Exchange Commission (SEC) was
formed. Periodic reports vouched by certified public accountants were filed by all publicly-traded
companies who had to register with the SEC before selling their securities to the public. Thus, the AICPA
was tasked to set the accounting and auditing standards for these reports until the establishment of the
Financial Accounting Standards Board (FASB) in 1973. The FASB is the result of the demand for more
reliable and comparable financial reporting by the Congress and SEC. Thus, the FASB and the
Governmental Accounting Standards Board (GASB) are currently two of the significant authorities
establishing the generally accepted accounting principles (GAAP) in the US. On the other hand, in response
to the continuing expansion of businesses, large accounting firms offered consultancy services aside from
their auditing function.

The Information Age

The Information Age, otherwise known as the Computer Age, Digital Age, or New Media Age, has
brought about a significant change in the work load of accountants. Manual, tedious and time-consuming
tasks were replaced by faster and more accurate computer methods. Transactions can be consummated
online with the help of the internet. Various software applications in accounting have been developed to
expedite procedures and accommodate the numerous needs and demands of the different businesses.

21st Century — Accounting in the Modern Times

The century opened with the replacement of the International Accounting Standards Committee
(IASC) by the International Accounting Standards Board (IASB) established in January 2001. In the same
year, the Enron Scandal, the greatest corporate fraud case recorded in American history, caused Arthur
Andersen, one of the top audit firms in the United States to close business. In order to protect investors
from corporate misinformation, the Sarbanes-Oxley Act was passed by the US Congress in 2002. This
imposed tougher restrictions on accountants conducting consultancy services.

The year '2008 witnessed tougher times with the economic recession in the United States. In
response to the Great Recession, the Dodd-Frank Act was signed into federal law on July 21, 2010. This
contains sixteen major areas of reform, including Financial Stability, Orderly Liquidation Authority,
Transfer of Powers to the Comptroller, the FDIC, and the Fed, Regulation of Advisers to Hedge Funds and
Others, Insurance, Improvements to Regulation, Wall Street Transparency and Accountability, Payment,
Clearing and Settlement Supervision, Bureau of Consumer Financial Protection, Federal Reserve System
Provisions, Improving Access to Mainstream Financial Institutions, Pay It Back Act, Mortgage Reform,
and Anti-Predatory Lending Act.

With constant developments in modern technology and the globalization of businesses, accountants
continue to cope up with the changing trends. Many countries including the Philippines have adopted the.
International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) in order
to support comparability and understandability of financial statements across the globe. As a result, the
accountants of today face greater and more complicated responsibilities. In addition, technology today
reduces the time, effort, and cost of recordkeeping, minimizes errors as well as processes, and summarizes
large volumes of data input. As such, accountants must always be updated with the latest innovations
affecting their profession.

LESSON 1-3 THE BUSINESS ENVIRONMENT

Lesson Objective
 differentiate the branches of accounting
 explain the types of services rendered in each brand of accounting
 know the different types of business organization
 know the legal requirement of formation of a business
 classify the different types of business operations

THE DIFFERENT BRANCHES OF ACCOUNTING

1. Financial Accounting
 Financial accounting deals with the theoretical framework covering accounting principles and
concepts relative to measurement and valuation as applied to assets, liabilities, stockholder's equity,
retained earnings, revenue, and expense accounts in relation to the preparation and presentation of
financial statements. These financial statements include disclosure requirements as governed by the
generally accepted accounting principles (GAAP).
 The financial information provided by financial accounting is used for decision making by both
internal and external users. Internal users include owners, shareholders, management, and employees
while external users include creditors, potential investors, and government agencies.

2. Management Accounting

 The Institute of Management Accountants (IMA) defines management accounting

as a profession that involves partnering in management decision making, devising
planning and performance management systems, and providing expertise in
financial reporting and control to assist management in the formulation and
implementation of an organization's strategy.

3. Government Accounting
 Section 109 of Presidential Decree (PI)) No. 1445 states that government accounting
encompasses the process of analyzing, classifying, summarizing, and communicating all
transactions involving the receipt and disposition of government funds and property, and
interpreting the results thereof. The agencies responsible in performing government accounting
 functions are the Commission of Audit (COA), the Department of Budget and Management
(DBM), and the Bureau of Treasury (BTr).

4. Auditing
 Auditing is the examination and review of accounting reports in order to ascertain their
fairness, propriety, and reliability. The independent auditor's opinion provides reasonable
assurance that the financial statements under examination fairly present the company's financial
position and results of operation in accordance with the generally accepted accounting
principles (GAAP).

5. Tax Accounting
 Tax services provided by accountants include the preparation of monthly value added tax,
percentage tax, expanded withholding tax returns, quarterly and annual tax returns, and any
other taxes applicable to business. Accountants work closely with clients in order to avoid tax
problems with the Bureau of Internal Revenue (BIR) and other local agencies through proper
tax compliance while advising clients about ways and measures to minimize taxes.
6. Cost Accounting
 Cost accounting includes the collection, determination, allocation, assessment,
interpretation, and control of cost data, particularly the cost of production in a manufacturing
concern. The cost of production includes the raw materials, direct labor, factory overhead, and
all other costs involved incident in each stage of production of the finished goods.

7. Accounting Education
 Accounting education involves planned grading and formal teaching in an educational
institution. The professional accountant imparts knowledge to students enrolled in an
accounting subject either in basic accounting or in higher accounting subjects. Accountants in
the academe usually take post graduate studies to achieve the required tenure.

8. Accounting Research
 Accounting research involves conducting a careful and diligent study aimed at discovering and
interpreting facts, revising accepted theories in the light of new facts, or the practical
application of such new or revised theories for the generation of a new knowledge.
 It includes collecting information about a particular subject in order to decide and implement
new standards in accounting, presenting current events that might affect the profession, or
discovering new theories that will have an impact on existing accounting knowledge.

Users of Financial Information

Internal Users
 Internal users are the primary users of financial information who are inside the reporting
entity and are directly involved in managing the company's daily operations. They are the
decision makers who make the strategic and operational decisions for the company.

1. Investors/ Owners/ Stockholders

 These parties provide the financial resources to keep the business going. They decide whether
to invest or not depending on the estimated amount of income on the investment. Upon
investment, they would want to know the financial position or results of operation of their
business investment.
2. Management
 Organizational managers use financial information to set goals for their companies. Managers
evaluate their progress towards these goals and use financial data as a guide for future
management actions.
3. Employees
  Although the employees are not directly involved in the decision making of the company, they
are nonetheless interested in the financial information of the company to determine if they have
a future in the company.

External Users
 External users are secondary users of financial information who are parties outside the
company. They may not be directly involved in the company's operations but their decisions
may significantly affect the business entity.
1. Financial Institutions/ Creditors
 Before extending credit, financial institutions use financial information to determine the
capacity of the business organization to pay its obligations and their interests at the appropriate
time.

2. Government
 Financial information is important for tax purposes and in checking of compliance with
Securities and Exchange Commission (SEC) requirements.

3. Potential Investors/ Creditors

 Before making an investment or extending credit, potential investors or creditors
may not only be interested in the company's current financial position and results of
operations, but also in the company's financial history. This should give them the
assurance that their investment will yield a reasonable rate of return or the credit
extended will be paid within a reasonable period of time.

Types of Business Organizations

1. Sole/ Single Proprietorship is a business owned and managed by only one person.

Advantages
a. There are minimal costs and requirements in the formation.
b. The owner can withdraw the assets and profits of the business anytime at his or her own
discretion.
c. Decision making is solely in the hands of the owner.
d. The duration of the life of the business solely depends on its owner.

Disadvantages
a. Resources are limited as the capital is provided only by the owner.
b. The liability of the owner is unlimited as he or she is accountable to all creditors of the
business.
c. Infusion of knowledge in the management of the business is limited to one person only,
which is the owner.

2. Partnership is a business organization owned and managed by two or more people who agree to
contribute money, property, or industry to a common fund for the purpose of earning a profit.

Advantages
a. There are minimal costs and requirements in the formation.
b. There are more funds contributed from the investment of the partners.
c. There is infusion of more knowledge, experience, and skills from two or more partners.
d. There can be division of labor between or among partners.

Disadvantages
 a. The partners are liable for the actions of each partner as a result of mutual agency.
b. A general partner has unlimited liability if the other partners are limited partners or
are insolvent.
c. Disagreement between or among partners can lead to the withdrawal of one or more partners.
d. The death, retirement, withdrawal, or incapacity of a partner results in the dissolution
of the partnership.
e. Admission of a new partner depends upon the approval of the other partners.

3. Corporation is a form of business organization managed by an elected board of directors. The

investors are called stockholders and the unit, of ownership is called share of stock.

Advantages
a. The stockholders only have limited liability, as their liability extends only up to the amount
of their capital investment.
b. A corporation has continuous existence as its life is indefinite.
c. There is more infusion of funds from the stockholders or investors.
d. Shares of stocks can be transferred without the consent of other shareholders.
e. Management of the corporation is vested upon its board of directors.

Disadvantages

a. A corporation entails many requirements and is more costly than a partnership.

b. The government exercises strict control over corporations and imposes high taxes.
c. Shareholders have little or no participation in the management of the corporation.
d. Distribution of net income depends upon the declaration of dividends by the board of
directors.
e. In large corporations, there is formal or impersonal relationship between employees and
management due to the big number of employees. Hence, chances of creating a personal and friendly
atmosphere in the corporate setting are minimal.

4. Cooperatives
Under Section 3 of Republic Act 6938, a cooperative is a duly registered association of persons, with a
common bond of interest, who have voluntarily joined together to achieve a lawful common social or
economic end, making equitable contributions to the capital required and accepting a fair share of the risks
and benefits of the undertaking in accordance with universally accepted cooperative principles.
In short, a cooperative is an association of small producers and consumers wh o come together
voluntarily to form a business which they own, manage, and patronize.

Advantages
a. The prices of products offered to consumers are lower due to direct purchases of cooperative
members from producers or manufacturers.
b. Cooperatives are managed by the members themselves; thus, saving on management costs
which leads to lower prices of products inuring to the benefit of the consumers.

Disadvantages
a. There is limited capital due to underprivileged members.
b. The cooperative is strictly for members only and shares cannot be transferred to non-
members.
c. Lack of efficient management as it is managed only by its members.

Legal Requirements in the Formation of a Business

 The sole proprietorship is the easiest business to register. It is registered with the Department of
Trade and Industry (DTI) under its Bureau of Trade Regulation and Consumer Protection.

For a partnership, the business is registered with the Securities and Exchange Commission (SEC)
upon submission of the following documents:
a. Proposed Articles of Partnership
b. Name Verification Slip
c. Bank Certificate Deposit
d. Alien Certificate of Registration, Special Investors Resident Visa, or proof of other types of
visa (in case of foreigners)
e. Proof of Inward Remittance (in case of non-resident aliens)

For a corporation, the following are the incorporation documents required to be filed With the
Securities and Exchange Commission (SEC):
a. Articles of Incorporation
b. By-laws
c. Treasurer's Affidavit which should state compliance with the authorized subscribed and paid-
up capital stock requirements.
d. Bank Certificate which should state that the paid-up capital portion of the authorized capital
stock has been deposited to the issuing bank

What should be stated upon registration of a corporation?

a. The name of the. corporation which must not be identical, or deceptively or confusingly
similar to any existing corporation
b. The purpose of the corporation
c. Principal office of the corporation
d. The term or life of the corporation, which should not exceed fifty (50) years. This Corporate
lifetime may, however, be extended for another fifty (50) years but the extension must not be effected earlier
than five (5) years before the expiration of its term.

For a cooperative, the business is registered with the Cooperative Development Authority (CDA)
upon submission of the following documents:
a. Economic Survey
b. Notarized Articles of Cooperation and By-Laws
c. Bonds of accountable officer or officers
d. Notarized sworn statement of the treasurer certifying that the required subscription and
payment of the authorized share capital and paid-up capital have been fulfilled.

Three Types of Business Activities/ Operations

1. Service is a type of business operation engaged in the rendering of services. A service type of
business earns based on the skill or quality of service it offers. In order for the business to grow, its people
or employees have to be trained. For example, a well known hair cutter cannot perform all the hair and
makeup services to his or her customers. He/she must train employees to replicate the quality of the service
he/she renders. Constant monitoring, evaluating, and updating of knowledge of the staff are necessary.
He/she has to continuously maintain, if not improve, the quality of service offered to his/her customers.

Examples: dental clinic, barbershop, laundry service

2. Trading/ Merchandising is a type of business engaged in the buying and selling of

goods. Merchandising includes the process of managing and marketing the products sold to its
customers. Sales have to be optimized in order to make money. Customer demands have to be
satisfied with the quality of products sold. The tedious processes of forecasting, purchasing, pricing,
and marketing of products in order to generate sales are essential in the trading or merchandising
business.

Examples: grocery, sari-sari store

3. Manufacturing is engaged in the production of items to be sold. It involves the

purchasing and converting of raw materials to finished goods. This type of business incurs overhead
costs aside from the wages and materials used in the production of goods. A rise in price in one of
these costs causes an increase in the price of goods produced. Aside from this, there are certain
expenses incurred even during periods of non-manufacturing such as rent, insurance, worker
benefits, and machine depreciation. Hence, careful planning is involved in manufacturing.

Examples: shoe factory, food processing

Conceptual Framework for Financial Reporting

Purpose and status of the Framework

The IFRS Framework describes the basic concepts that underlie the preparation and presentation of financial
statements for external users. The IFRS Framework serves as a guide to the Board in developing future
IFRSs and as a guide to resolving accounting issues that are not addressed directly in an International
Accounting Standard or International Financial Reporting Standard or Interpretation.
In the absence of a Standard or an Interpretation that specifically applies to a transaction, management must
use its judgment in developing and applying an accounting policy that results in information that is relevant
and reliable. In making that judgment, IAS 8.11 requires management to consider the definitions,
recognition criteria, and measurement concepts for assets, liabilities, income, and expenses in the IFRS
Framework. This elevation of the importance of the [IFRS] Framework was added in the 2003 revisions to
IAS 8.

The IFRS Framework

Scope
The IFRS Framework addresses:
 the objective of financial reporting
 the qualitative characteristics of useful financial information
 the reporting entity
 the definition, recognition and measurement of the elements from which financial statements
are constructed
 concepts of capital and capital maintenance

Chapter 1: The Objective of general purpose financial reporting

 The primary users of general purpose financial reporting are present and potential investors, lenders and
other creditors, who use that information to make decisions about buying, selling or holding equity or
debt instruments and providing or settling loans or other forms of credit. [F OB2]
 The primary users need information about the resources of the entity not only to assess an entity's
prospects for future net cash inflows but also how effectively and efficiently management has discharged
their responsibilities to use the entity's existing resources (i.e., stewardship). [F OB4]
 The IFRS 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. [F OB6]
 The IFRS Framework notes that other parties, including prudential and market regulators, may find
general purpose financial reports useful. However, the Board considered that the objectives of general
purpose financial reporting and the objectives of financial regulation may not be consistent. Hence,
regulators are not considered a primary user and general purpose financial reports are not primarily
directed to regulators or other parties. [F OB10 and F BC1.20-BC 1.23]

Economic resources and claims

 Information about the nature and amounts of a reporting entity's economic resources and claims
assists users to assess that entity's financial strengths and weaknesses; to assess liquidity and
solvency, and its need and ability to obtain financing. Information about the claims and payment
requirements assists users to predict how future cash flows will be distributed among those with a
claim on the reporting entity. [F OB13]
 A reporting entity's economic resources and claims are reported in the statement of financial
position. [See IAS 1.5480A]

Changes in economic resources and claims

 Changes in a reporting entity's economic resources and claims result from that entity's performance
and from other events or transactions such as issuing debt or equity instruments. Users need to be
able to distinguish between both of these changes. [F OB15]
 Financial performance reflected by accrual accounting
 Information about a reporting entity's financial performance during a period, representing changes in
economic resources and claims other than those obtained directly from investors and creditors, is
useful in assessing the entity's past and future ability to generate net cash inflows. Such information
may also indicate the extent to which general economic events have changed the entity's ability to
generate future cash inflows. [F OB18-OB19]
 The changes in an entity's economic resources and claims are presented in the statement of
comprehensive income. [See IAS 1.81-105]
 Financial performance reflected by past cash flows
Information about a reporting entity's cash flows during the reporting period also assists users to assess the
entity's ability to generate future net cash inflows. This information indicates how the entity obtains and
spends cash, including information about its borrowing and repayment of debt, cash dividends to
shareholders, etc. [F OB20]
 The changes in the entity's cash flows are presented in the statement of cash flows. [See IAS 7]
  Changes in economic resources and claims not resulting from financial performance
Information about changes in an entity's economic resources and claims resulting from events and
transactions other than financial performance, such as the issue of equity instruments or distributions of cash
or other assets to shareholders is necessary to complete the picture of the total change in the entity's
economic resources and claims. [F OB21]
 The changes in an entity's economic resources and claims not resulting from financial performance is
presented in the statement of changes in equity. [See IAS 1.106-110]

Chapter 2: The Reporting entity

The chapter on the Reporting Entity will be reconsidered as part of the IASB's comprehensive project on the
framework.

Chapter 3: Qualitative characteristics of useful financial information

The qualitative characteristics of useful financial reporting identify the types of information are likely to be
most useful to users in making decisions about the reporting entity on the basis of information in its
financial report. The qualitative characteristics apply equally to financial information in general purpose
financial reports as well as to financial information provided in other ways. [F QC1, QC3]
Financial information is useful when it is relevant and represents faithfully what it purports to represent. The
usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable. [F
QC4]
Fundamental qualitative characteristics
 Relevance and faithful representation are the fundamental qualitative characteristics of useful
financial information. [F QC5]
Relevance
 Relevant financial information is capable of making a difference in the decisions made by users.
Financial information is capable of making a difference in decisions if it has predictive value,
confirmatory value, or both. The predictive value and confirmatory value of financial information are
interrelated. [F QC6-QC10]
 Materiality 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. [F
QC11] Faithful representation
 General purpose financial reports represent economic phenomena in words and numbers, To be
useful, financial information must not only be relevant, it must also represent faithfully the
phenomena it purports to represent. This fundamental characteristic seeks to maximize the
underlying characteristics of completeness, neutrality and freedom from error. [F QC12] Information
must be both relevant and faithfully represented if it is to be useful. [F QC17]

Enhancing qualitative characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the
usefulness of information that is relevant and faithfully represented. [F QC19]
1. Comparability
Information about a reporting entity is more useful if it can be compared with a similar information about
other entities and with similar information about the same entity for another period or another date.
Comparability enables users to identify and understand similarities in, and differences among, items. [F
QC20-QC21]
2. Verifiability
Verifiability helps to assure users that information represents faithfully the economic phenomena it purports
to represent. Verifiability means that different knowledgeable and independent observers could reach
consensus, although not necessarily complete agreement, that a particular depiction is a faithful
representation. [F QC26]
3. Timeliness
Timeliness means that information is available to decision-makers in time to be capable of influencing their
decisions.
[F QC29]
 4. Understandability
Classifying, characterizing and presenting information clearly and concisely makes it understandable. 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. [F QC30-QC32]

Applying the enhancing qualitative characteristics

 Enhancing qualitative characteristics should be maximized to the extent necessary. However,
enhancing qualitative characteristics (either individually or collectively) render information useful if
that information is irrelevant or not represented faithfully. [F QC33]
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. [F QC35-QC39]

Chapter 4: The Framework: the remaining text

Chapter 4 contains the remaining text of the Framework approved in 1989. As the project to revise the
Framework progresses, relevant paragraphs in Chapter 4 will be deleted and replaced by new Chapters in
the IFRS Framework. Until it is replaced, a paragraph in Chapter 4 has the same level of authority within
IFRSs as those in Chapters 1-3.

Underlying assumption

 The IFRS Framework states that the going concern assumption is an underlying assumption.

 Going concern 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. [F 4.1]

 Accounting Entity means that the entity is separate from the owners, managers, and employees who
constitute the entity.

 Time Period requires that the indefinite life of an entity is subdivided into time periods or
accounting periods which are usually of equal length for the purpose of preparing financial reports.

 Monetary unit has two aspects, quantifiability and stability.

 Quantifiability means that the assets, liability, equity, income and expense should be stated in terms
of unit of measure which is the peso in the Philippines.

 Stability of peso means that the purchasing power of peso is stable or constant and that its instability
is insignificant and therefore may be ignored.

Chapter 5: The elements of financial statements

 Financial statements portray the financial effects of transactions and other events by grouping them
into broad classes according to their economic characteristics. These broad classes are termed the
elements of financial statements.
 The elements directly related to financial position (balancesheet) are:
[F 4.4]
  Assets
 Liabilities

 Equity

The elements directly related to performance (income statement) are: [F

4.25]
 Income
 Expenses

The cash flow statement reflects both income statement elements and some changes in balance sheet
elements.
Definitions of the elements relating to financial position
 Asset. An asset is 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. [F 4.4(a)]

 Liability. A liability is 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.
[F 4.4(b)]

 Equity. Equity is the residual interest in the assets of the entity after deducting all its liabilities. [F
4.4(c)]

Definitions of the elements relating to performance

 Income. Income is 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. [F 4.25(a)]
 Expense. Expenses are 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. [F 4.25(b)]

 The definition of income encompasses both revenue and gains. 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. Gains represent other items that meet the definition of
income and may, or may not, arise in the course of the ordinary activities of an entity. Gains
represent increases in economic benefits and as such are no different in nature from revenue. Hence,
they are not regarded as constituting a separate element in the IFRS Framework. [F 4.29 and F 4.30]
 The definition of expenses encompasses losses as well as those expenses that arise in the course of
the ordinary activities of the entity. Expenses that arise in the course of the ordinary activities of the
entity include, for example, cost of sales, wages and depreciation. They usually take the form of an
outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and
equipment. Losses represent other items that meet the definition of expenses and may, or may not,
arise in the course of the ordinary activities of the entity. Losses represent decreases in economic
benefits and as such they are no different in nature from other expenses. Hence, they are not
regarded as a separate element in this Framework. [F 4.33 and F 4.34]
 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: [F 4.37 and F
4.38]
 It is probable that any future economic benefit associated with the item will flow to or from the

entity; and

 The item's cost or value can be measured with reliability.

Based on these general criteria:

 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.
[F 4.44]
 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. [F 4.46]

 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). [F 4.47]

 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). [F 4.49]

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. [F 4.54]
The IFRS Framework acknowledges that a variety of measurement bases are used today to different degrees
and in varying combinations in financial statements, including: [F 4.55]
o Historical cost
 is the measurement basis most commonly used today, but it is usually combined with other
measurement bases. [F. 4.56] 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.
o Current cost

 Is the amount of cash or cash equivalent that would have to be paid if the same of equivalent asset
was acquired currently.

o Net realizable (settlement) value

 Is the amount of cash or cash equivalent that could currently be obtained by selling the asset in an
orderly disposal.

o Present value (discounted)

 Is the discounted value of the future net cash inflows that the item is expected to generate in the
normal course of business.