COLLEGE OF ACCOUNTANCY

C-AE14 Conceptual Framework and Accounting Standards

First Semester AY 2021-2022

A. Course Code – Title : C-AE14 – Conceptual Framework and Accounting Standards B. Module
No – Title : Module 9 The Elements of Financial Statements (Liabilities, Equity, Income and
Expenses)
C. Time Frame : 1 weeks – 6 hrs

D. Overview
This module deals with the continuation of Chapter 4 of the Conceptual Framework for
Financial Reporting. Liabilities, equity, income and expenses are defined and discussed in
detail.

You will still use the downloaded set of actual financial statements in Module 7and apply the
concepts learned in this module by identifying the elements of financial statements.

You still have to read and understand Chapter 4 of the Conceptual Framework. This module
only discusses the salient points and not every paragraph in the chapter. If you have
questions pertaining to some items in Chapter 4, feel free to ask them during the online
sessions or through the Google Classroom or any other previously agreed upon means.

E. Desired Learning Outcomes

Our goal is that, upon completing this module, you will be able to accomplish the
following learning outcomes:
€ “I can provide the definition of a liability, equity, income and expense based on the
provisions of the conceptual framework.”
€ “I can cite some examples of liabilities, equity, income and expense accounts, and discuss
why these are to be considered as such.”

F. Values Integration
In studying this module, it is hoped that you will be able to develop and manifest the
following UA Core Value/s:
✓ Integrity

✓ Excellence

✓ Service Orientation

✓ Open Communication

G. Interaction/Collaboration
You will be engaging in activities that would make use of:
✓ Google Forms
 ✓ Google Docs

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 1

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

H. Content/Discussion

Review:

Module 8 was dedicated to understanding the definition of an asset. This is a very important task
simply because the definitions of the other elements of financial statements are significantly
affected by the definition of an asset.

In determining whether an asset exists, you should look into the three vital aspects of the
definition: a) Right
b) Potential to produce economic benefits; and,
c) Control

These assets are sourced from entities which have, in one way or another, have claims over the
business. Thus, we recall the accounting equation:

ASSETS = LIABILITIES + EQUITY

This equation tells us that creditors and owners have claims over the entity’s assets. We will now
deal with the definition of these terms: Liability and Equity, including Income and Expenses which
will affect equity by either increasing or decreasing it.

Lesson 1 – Definition of Liability

Before we properly define a liability, please try to answer the following based on your personal
opinion. We will see how your answers will change (or not) after we have discussed all pertinent
items about liabilities.

For each item, state whether the company has a liability and briefly explain your answer.
a. Company A employed Mr. Super Man.

b. Company B obtained a loan from a bank. The first installment is due in November 2022.
 c. Company C is recognized by the public for decades since its formation in terms of providing
free repair for its goods up to two years from the time of sale. Today, it was able to sell 500
units of its goods to customers from all over the country.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 2

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

d. Company D produces a device that has a very toxic by-product. A new law was just signed by
the president penalizing the improper disposal of this by-product.

e. Company E intends to purchase goods on account from Company B.

The Conceptual Framework provides that a liability is a present obligation of the entity to transfer
an economic resource as a result of past events.

Let us present the definitions of an asset and a liability side by side:

Asset Liability
Present economic resource (rights Present obligation (duty or
that have the potential to produce responsibility)
economic benefits)

Controlled by the entity To transfer an economic resource As a result of past

events As a result of past events

Take note that both definitions are similar in a way, particularly in using the terms “present” and “as
a result of past events”.

You may also note that the asset one entity controls may be the same asset that can be transferred to
another entity in order to settle or fulfill the obligation.

Another thing worth considering is that the obligation of one party corresponds to the right of
another party.

For a liability to exist, three criteria must ALL be satisfied:

 a) The entity has an obligation;
b) The obligation is to transfer an economic resource; and,
c) The obligation is a present obligation that exists as a result of past events.

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COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022
Resource obtained economic
benefits or taken an
• obligation must have action; and,
the potential to • as a consequence, the
require the entity to entity will or may
transfer an economic have to transfer an
resource to another economic resource it
Obligation would not otherwise
party (or parties)
• duty or responsibility have had to transfer.
that an entity has no
practical ability to
avoid
Present Obligation as a
Result of Past Events

• the entity has already

Transfer an Economic

These criteria are discussed in detail in the succeeding sections.

Obligation

The first criterion for a liability is that the entity has an obligation which is a duty or responsibility
that an entity has no practical ability to avoid.

The phrase “no practical ability to avoid” was already mentioned in the previous module when we
discussed that an entity may obtain rights through an obligation of another party that arises
because that other party has no practical ability to act in a manner inconsistent with its customary
practices, published policies or specific statements.

Remember that an obligation is ALWAYS owed to another party (or parties). The other party (or
parties) could be:
 a) a person or another entity
Example: Accounts payable to a supplier/vendor

b) a group of people or other entities,

Example: Salaries payable to employees, dividends payable to shareholders (shareholders
may be a group of people or other entities)

c) society at large
Example: Income taxes payable to the government, amounts to be paid to a community in
case the entity is directed by a court of law to pay damages caused by environmental
degradation from the entity’s actions or processes

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COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

The Conceptual Framework is very specific in saying that it is NOT necessary to know the identity of
the party (parties) to whom the obligation is owed.

For example, a company selling gadgets or devices have the obligation to honor product warranties
should any after-sales issue arise in the gadget or device sold. Once the items have been sold, an
obligation already exists although it is still uncertain who among the customers will avail of such
warranties.

If one party has an obligation to

transfer an economic resource, parties must recognize and resource
it follows that another party (or measure the liability and asset
parties) has a right to receive at the Right to receive that
that economic resource. It does economic resource
not follow, however, that both
Obligation to transfer an
economic

same amount. Standards may contain different

recognition criteria or measurement requirements if those different criteria or requirements are a
consequence of decisions intended to select the most relevant information that faithfully represents
what it purports to represent.

As with assets, many obligations are established by contract, legislation or similar means and are
legally enforceable by the party (or parties) to whom they are owed. Obligations may also arise from
the entity’s customary practices, published policies or specific statements IF the entity has no
practical ability to act in a manner inconsistent with those practices, policies or statements. The
obligation that arises in such situations is sometimes referred to as a “CONSTRUCTIVE
OBLIGATION”.
Other concerns about an entity’s obligation may be as follows:

1. An entity’s duty or responsibility to transfer an economic resource is CONDITIONAL on a

particular future action that the entity itself may take. The entity already has an obligation
IF it has no practical ability to avoid taking that action.
2. If the going concern basis is used, then this also implies that the entity has no practical ability
to avoid a transfer that could be avoided ONLY by liquidating the entity or by ceasing to trade. 3.
The factors used to assess whether an entity has the practical ability to avoid transferring an
economic resource may depend on the nature of the entity’s duty or responsibility. 4. In some
cases, it is uncertain whether an obligation exists like in the case of another party seeking
compensation for an entity’s alleged act of wrongdoing. Until that uncertainty is resolved – for
example by a court ruling – it is uncertain whether the entity has an obligation to the party
seeking compensation, and consequently, whether a liability exists.

Transfer of an economic resource

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COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

To satisfy this criterion, the obligation must have the potential to require the entity to transfer an
economic resource to another party (or parties).

For that potential to exist, IT DOES NOT NEED TO BE CERTAIN, or even likely, that the entity will be
required to transfer an economic resource.

It is only necessary that the obligation already exists and that, in at least one circumstance, it
would require the entity to transfer an economic resource.

An obligation can meet the definition of a liability even if the probability of a transfer of an
economic resource is low. This low probability, however, might affect decisions about what
information to provide about the liability and how to provide that information, including decisions
about whether the liability is recognized and how it is measured.

Obligations to transfer an economic resource may be an obligation to:

a) Pay cash;
b) Deliver goods or provide services;
c) Exchange economic resources with another party on unfavorable terms;
d) Transfer an economic resource if a specified uncertain future event occurs; or e) Issue a
financial instrument if that financial instrument will oblige the entity to transfer and economic
resource.

Instead of transferring an economic resource to settle or fulfill an obligation, entities may

sometimes decide to:

a) Settle the obligation by negotiating a release from the obligation;

b) Transfer the obligation to a third party; or
c) Replace that obligation to transfer an economic resource with another obligation by entering
into a new transaction.

In other words:

AN ENTITY HAS THE OBLIGATION TO TRANSFER AN ECONOMIC RESOURCE UNTIL IT HAS

SETTLED, TRANSFERRED OR REPLACED THAT OBLIGATION.

Present obligation as a result of past events

A present obligation exists as a result of PAST EVENTS only if:

a) The entity has already obtained economic benefits or taken an action; and b) As a
consequence, the entity will or may have to transfer an economic resource that it would not
otherwise have had to transfer.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 6

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting
Standards First Semester AY 2021-2022

In the PAST the entity obtained

•goods
Economic •services Resulting to a
benefits PRESENT
or has taken obligation
•operating a
•operating in a
Action particular
particular market
business

If the entity has not yet obtained economic benefits, or taken an action, that would or could require
the entity to transfer an economic resource, then the entity does not yet have a present obligation to
transfer a resource.

Example: when an employee is hired and the employment contract is signed, the entity does not
have a present obligation to pay the salary until it has received the employee’s services.
Obligation accumulating over time

If economic benefits are obtained, or an action is taken, over time, the resulting present obligation
may accumulate over that time.

Example: If resources were obtained, like cash, through long-term financing, then the liability would
also accumulate over time. The entity would have to pay additional amounts for the use of that cash.
This is most commonly referred to as interest or finance cost.

Obligation when a new legislation is enacted

The enactment of legislation is not in itself sufficient to give an entity a present obligation. A present
obligation arises only when as a consequence of obtaining economic benefits or taking an action to
which that legislation applies, an entity will or may have to transfer an economic resource that it
would not otherwise have to transfer.

Transfer of resources that cannot be enforced until some future time

A present obligation can exist even if

a) a transfer of economic resources cannot be enforced until some future point in time.

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COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

Example: a contractual liability to pay cash may exist now even if the contract does not require a
payment until a future date - “buy now, pay later promo”

b) a contractual obligation for an entity to perform work at a future date may exist now even if the
counterparty cannot require the entity to perform the work until that future date

Example: an event organizer was contracted to provide services on the 18th birthday celebration
of a young lady two months from now

Unit of account

Unit of account pertains to the right or the group of rights, the obligation or the group of obligations,
or the group of rights and obligations, to which recognition criteria and measurement concepts are
applied. A unit of account is selected for an asset or liability when considering how recognition
criteria and measurement concepts will apply to that asset or liability and to the related income and
expenses.

Transfers of part of an asset or liability

If an entity transfers part of an asset or part of a liability, the unit of account may change at that
time, so that the transferred component and the retained component become separate units of
account.

Example: A prepaid insurance good for one year has an expired portion equivalent to half of its
amount. The expired portion becomes the expensed amount while the unexpired portion is the
retained component in the asset account.

Cost as a constraint

In selecting a unit of account, it is important to consider whether the benefits of the information
provided to users of financial statements by selecting that unit of account are likely to justify the
costs of providing and using that information.

Rights and obligations arising from the same source

1. If rights and obligations are interdependent and cannot be separated, they constitute a single
inseparable asset or liability and hence form a single unit of account.
2. If rights are separable from obligations, this result in the identification of one or more
separate assets and liabilities.
3. It may sometimes be more appropriate to group separable rights and obligations in a single
unit of account treating them as a single asset or a single liability.
4. Treating a set of rights and obligations as a single unit of account differs from offsetting assets
and liabilities.

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COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

Possible units of account include:

a) An individual right or individual obligation;

b) All rights, all obligations, or all rights and all obligations, arising from a single source;
(example – a contract)
c) A subgroup of those rights and/or obligations; (example – a subgroup of rights over an item
of PPE for which the useful life and pattern of consumption differ from those of the other
rights over that item)
d) A group of rights and/or obligations arising from a portfolio of similar items; e) A group of
rights and/or obligations arising from a portfolio of dissimilar items; (example - a portfolio of
assets and liabilities to be disposed of in a single transaction); and, f) A risk exposure within a
portfolio of items-if a portfolio of items is subject to a common risk, some aspects of the
accounting for that portfolio could focus on the aggregate exposure to that risk within the
portfolio
The aforementioned enumeration may seem a bit too technical for you, my dear first year students.
Needless to say, it is important that as early as now, you become aware of the fact that the selection
of a unit of account depends on factors like the qualitative characteristics of useful financial
information, nature of the economic phenomena, risk involved, and cost, among other things.

Don’t worry because these items will still be dealt with in your higher accounting courses when you
study each account and complete the preparation, as well as the interpretation, of the financial
statements.

Executory contracts

Still on assets and liabilities, one concept that you need to know is executory contract. This is a
contract, or a portion of a contract, that is equally UNPERFORMED – neither party has fulfilled any
of its obligations, or both parties have partially fulfilled their obligations to an equal extent. For
example, today, Tom agreed to sell to his friend, John, his old van for P350,000. If Tom will deliver
the van to John, then he can expect that John will pay him the agreed upon amount.

At the time the agreement or contract was entered into, each of the parties has a combined right and
obligation. When one party performs his end of the bargain first, this combined right and obligation
becomes an asset. The counterparty’s combined right and obligation then becomes a liability.

On the day of their agreement, when each of them has not yet performed their end of the contract,
the contract is considered an EXECUTORY CONTRACT, or one that is yet to be executed. But once a
party already performs his end of the bargain, then, the contract is not executor anymore. There is
already a right to receive an economic resource for one of the parties while the counterparty has an
obligation to transfer an economic resource. Again, the right is an asset, and the obligation is a
liability.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 9

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

Can you think of another example of an executory contract?

Substance over form

Financial statements tell a story about the “substance” of the terms of the contract that created the
rights and obligations for an entity that is a party to that contract.

1. In some cases, the substance of the rights and obligations is clear from the legal form of the
contract. While in other cases, you may have to analyze further the contracts in order to
identify the substance of the rights and obligations.
2. All terms in a contract – whether explicit or implicit – are considered unless they have no
 substance. Terms that have no substance are disregarded

Lesson 2 – Definition of Equity

The Framework defines equity as the residual interest in the assets of the entity AFTER deducting
all its liabilities. Therefore, this statement can also be expressed as follows:

Assets – Liabilities = Equity

This also means that claims against the entity that do not meet the definition of a liability are to be
considered as equity. Such claims may be established by contract, legislation and similar means,
and include, to the extent that they do not meet the definition of a liability:

a) Shares of various types, issued by the entity; and

b) Some obligations of the entity to issue another equity claim.

Examples of different classes of equity claims:

a) Ordinary shares
b) Preference shares

Effect of legal, regulatory or other requirements on components of equity

Share capital or retained earnings may be subject to legal, regulatory or other requirements. As
accountants, you have to be aware of these requirements.

For example, there are some requirements that may permit an entity to make distributions to
holders of equity claims only if the entity has sufficient reserves that those requirements specify as
being distributable.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 10

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

For corporations, dividends are paid out of unrestricted retained earnings. “Unrestricted” means
that this is the “free” portion of the retained earnings or the portion that does not have any
restriction or limitation as to its use. Another way of saying it is that this unrestricted portion is not
“earmarked” for a specific purpose such as but not limited to plant expansion or increase in
capitalization.

You should also consider the type of organization of the reporting entity – whether it is a sole
proprietorship, partnership, corporation or other forms of organizations and the corresponding
legal or regulatory framework that applies for these types of organizations or activities. You will
learn more about this in your next accounting, taxation and law courses.

Lesson 3 – Definition of Income and Expenses

As mentioned in the
preceding module, financial equity claims.
performance pertains to how
well the entity has operated
Financial
within the accounting period. Performance
This can be described through
increases and decreases in
equity, except for those relating
to contributions from or
distributions to holders of Income Expenses

Income is defined as increases in assets, or decreases in liabilities that result in increases in equity,
other than those relating to contributions from holders of equity claims.

Contributions from holders of equity claims – are NOT income!

Example - original investment or additional investment by the owner/s of a business

Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other
than those relating to distributions to holders of equity claims.

Distributions to holders of equity claims- are NOT expenses!

Example – drawings, dividends

Let us present these two definitions side by side:

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 11

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

Income Expenses
Increases in assets or Decreases in assets or
Decreases in liabilities that Increases in liabilities that
Result in increase in equity Result in decrease in equity
Other than contributions from holders Other than distributions to holders
of equity claims of equity claims
What can you say about the definition of the two terms?

Yes! These two terms are opposites!

4. Progress Check:
1. Provide the definition of the following terms based on the provisions of the Conceptual
Framework:
a. Liability

b. Equity

c. Income

d. Expenses

2. Cite examples of liabilities, equity, income and expense accounts. Provide a brief description
of each, considering the definitions that you provided in number 1.
Liabilities Description

1.

2.

3.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 12

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022

Equity Description

1.

2.
 3.

Income Description

1.

2.

3.

Expenses Description

1.

2.

3.

Let’s check your progress:

€ “I can provide the definition of a liability, equity, income and expense based on the
provisions of the conceptual framework.”
€ “I can cite some examples of liabilities, equity, income and expense accounts, and discuss
why these are to be considered as such.”

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 13

COLLEGE OF ACCOUNTANCY
C-AE14 Conceptual Framework and Accounting Standards
First Semester AY 2021-2022
 5. Assignment/Enrichment - Let us go back to the questions before the discussion. Will your
answers change? For each item, state whether the company should recognize a liability and
briefly explain your answer.

a. Company A employed Mr. Super Man.

b. Company B obtained a loan from a bank. The first installment is due in November 2022.

c. Company C is recognized by the public for decades since its formation in terms of providing
free repair for its goods up to two years from the time of sale. Today, it was able to sell 500
units of its goods to customers from all over the country.

d. Company D produces a device that has a very toxic by-product. A new law was signed by the
president penalizing the improper disposal of this by-product.

e. Company E intends to purchase goods on account from Company B.

6. Evaluation – to be uploaded as a separate Google Form

E. References
Cabrera, M. E., Ocampo, R. R., & Cabrera, G. A. (2018). Conceptual Framework and Accounting
Standards. Manila, Philippines: GIC Enterprises & Co., Inc.

Empleo, P. M., & Robles, N. S. (2019). The Philippine Financial Reporting Conceptual
Framework and Accounting Standards. Mandaluyong City, Philippines: Millennium Books,
Inc.

IFRS Foundation. (2017). ifrs.org. Retrieved June 11, 2020, from https://www.ifrs.org/use
around-the-world/use-of-ifrs-standards-by-jurisdiction/philippines/#participant

International Accounting Standards Board. (2018, March). Conceptual Framework for

Financial Reporting. London, United Kingdom.

Millan, Z. V. (2019). Conceptual Framework and Accounting Standards. Baguio City,

Philippines: Bandolin Enterprise Publishing and Printing.

PLDT. (2020). 2019 Annual Reports Financial Section. Retrieved June 27, 2020, from
pldt.com: http://www.pldt.com/investor-relations/annual-and-sustainability
reports#AnnualReports

Valix, C. T., Peralta, J. F., & Valix, C. A. (2019). Conceptual Framework and Accounting
Standards. Manila, Philippines: GIC Enterprises & Co., Inc.

Faculty: Rosalinda E. Perez, CPA, MBA, LPT Page 14