CONCEPTUAL FRAMEWORK AND ACCOUNTING STANDARDS

Lesson 2: PAS 7 – Statement of Cash Flows

PAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors
PAS 10 – Events After Reporting Period
PAS 12 - Income Taxes
Lesson Objectives:
1. Describe the statement of cash flows and differentiate the different activities.
2. Differentiate between the accounting treatments of the following: change in
accounting policy, change in accounting estimate, and correction of prior period
error.
3. Define and state the accounting requirements for events after the reporting period.
4. Apply the prescribed standards in connection with different events that occurred after
the reporting period.
5. Understand the scope and the fundamental principle of PAS 12; interpret the
terminology used in the accounting for current and deferred taxes; state the
recognition, measurement and presentation of current and deferred taxes.

Discussion:
Lesson 2.1 PAS 7 – Statement of Cash Flows
The statement of cash flows provides information to users about the entity’s ability to
generate cash and cash equivalents, its timing and certainty of the generation of cash flows
and its utilization during the period and should be presented as an integral part of the entity’s
financial statements. It also shows the entity’s ability to adapt to changing business
circumstances.

- Classification of cash flows:

o Operating activities – primarily derived from the revenue-producing activities
of the entity which usually include cash inflows and outflows on items of
income and expenses
 Cash receipts from the sale of goods and services
 Cash receipts from royalties, fees commissions and other revenues
 Cash payments for purchases of goods and services
 Cash payments to and on behalf of employees
 Cash receipts and payments from contracts held for dealing and
trading purposes
 Cash flows from special items
 From buying and selling held for trading securities
 From the acquisition of property, plant and equipment to be
held for rental to others and subsequent sale of such assets
 Loan transactions of financial institutions
o Investing activities – involve the acquisition and disposal of non-current
assets and other investments
  Cash receipts and payments in the acquisition and disposal of
property, plant and equipment, investment property, intangible and
other non-current assets.
 Cash receipts and payments in the acquisition and sale of equity and
debt instruments of other entities other than those that are classified
as cash and cash equivalents and held for trading.
 Cash advances and loans to other parties and collections thereof other
than made by financial institutions.
o Financing activities – shows the share of cash which the entity’s capital
providers have claimed during the period and an indicator of likely future
interest and dividend payments.
 Cash proceeds from issuing shares or other equity instrument
 Cash payments to owners to acquire or redeem the entity’s shares
 Cash proceeds from issuing debentures, loans, notes, bonds,
mortgages and other short-term or long-term borrowings and their
repayments
 Cash payments by a lessee for the reduction of the liability relating to
finance lease. However, amount paid pertaining to interest will be
shown under operating activities.
- Presentation of cash flows from operating activities
o Direct method – shows each major class of gross cash receipts and gross cash
payments
o Indirect method – profit or loss is adjusted for the effects of non-cash items
and changes in operating assets and liabilities.
- Changes in ownership interests in subsidiaries
o Cash flows arising from acquisition and disposal of subsidiary or other
business units resulting to loss or obtaining of control are classified as
investing activities
o Those that do not result to loss or obtaining of control are classified as
financing activities.
- Disclosures required:
o Components of cash and cash equivalents and a reconciliation of amounts in
the statement of cash flows with the equivalent items in the statement of
financial position
Significant cash and cash equivalents held by the entity that are not available for use by the
group, together with management commentary.

Lesson 2.2 PAS 8: Accounting Policies, Changes in Accounting Estimates and Errors
Accounting Policies are specific principle, bases, conventions, rules and practices applied by
an entity in preparing and presenting financial statements. A change in accounting policy
usually results from a change in measurement basis. When selecting and applying accounting
policies, the entity shall follow the hierarchy of reporting standards, as follows:
1. PFRSs
2. Judgment, where management shall consider the following:
a. Requirements in other PFRSs dealing with similar transactions
b. Conceptual framework
Management may also consider the following:
 a. Pronouncements issued by other standard-setting bodies
b. Other accounting literature and industry practices.
Examples:
a. Change from FIFO to weighted average cost for inventories.
b. Change from cost model to revaluation model of measuring investment property,
property, plant and equipment and intangible assets
c. Change in business model for classifying financial assets
d. Change in the method of recognizing revenue from long term construction
contracts
e. Change to a new policy resulting from the requirement of new PFRS
f. Change in financial reporting framework such as from PFRS for SMEs to full
PFRSs
Changes in Accounting Estimates refers to adjustment of carrying amount of an asset or a
liability or the amount of the periodic consumption of an asset that results from the
assessment of the present status of, and expected future benefits and obligations associated
with assets and liabilities. These result from new information or new developments.
Examples:
a. Change in depreciation method
b. Change in estimated useful life or residual value of a depreciable asset
c. Change in the required balance of allowance for uncollectible accounts or
impairment losses.
d. Change in estimated warranty liability and other provisions.
Errors include misapplication of accounting policies, mathematical mistakes, oversights or
misinterpretations of facts, and fraud. The two types of error according to the period of
occurrence are: current period errors and prior period errors. Current period errors are errors
which are discovered in the current period or after the current period but before the financial
statements were authorized for issue which can be corrected by correcting entries. Prior
period errors are errors in one or more prior periods that were only discovered either in the
current period or after the current period but before the financial statements were authorized
for issue which can be corrected by retrospective restatement.
Retrospective restatement means:
1. Restating the comparative amounts for the prior period(s) presented in which the
error occurred.
2. If the error occurred before the earliest prior period presented, restating the opening
balances of assets, liabilities and equity for the earliest prior period presented.
Retrospective restatement shall be made as far back as practicable. If it is impracticable, the
entity is allowed to correct the error prospectively from the earliest date practicable.
Examples:
 a. Material errors are those that cause the financial statements to be misstated.
b. Intentional errors are fraud, regardless whether error is material or
immaterial.
c. Error of commission is doing something wrong.
d. Error of omission is not doing something that should have been done.

Scope of PAS 8 Description Accounting treatment Effect of Adjustment

Change in accounting Change in measurement a. Transitional In the beginning
policy basis provision balance of retained
b. Retrospective earnings, if accounted
application for retrospectively
c. If (b) is
impracticable,
prospective application
Change in accounting Changes in the Prospective application In profit or loss of
estimate realization of expected current period or
inflow/outflow of current and future
economic benefits from periods, if change
assets or liabilities affects both
Correction of prior Misapplication of a. Retrospective In the beginning
period error principles, oversight or restatement balance of retained
misinterpretation of b. If (a) is earnings, if accounted
facts, and mathematical impracticable, for retrospectively.
mistakes prospective application

Lesson 2.3 PAS 10: Events After Reporting Period

Events after the reporting period are those events, favorable and unfavorable, that occur
between the end of the reporting period and the date when the financial statements are
authorized for issue.
[Since you already know what reporting or accounting period is, discussion will be centered
on when financial statements are authorized for issue. The audit of financial statements are
conducted usually after the end of the reporting period. If the reporting period ends in
December 31, external audit usually takes place in January and expected to be finished before
the April 15 of the succeeding year when the entity files its annual income tax return, wherein
BIR requires that it should be audited by an independent auditor/CPA. After the audit of
financial statements, previously resented by the entity’s accounting department, the auditor
discusses with the management the results of his audit which includes adjustments made in
accordance with standards, etc. The management will then approve (this is the date when it is
authorized for issue) the final financial statements for the auditor to finalize, print and deliver
to the entity.]

Types of events after the reporting period:

1. Adjusting events, are those events that provide evidence of conditions that existed at the
end of the reporting period.
Examples of adjusting events:
a. Evidence of a permanent diminution in property value prior to the year end.
b. Sale of inventory after the reporting period for less than its carrying value at the year
end
c. Insolvency of a customer with a balance owing at the year end.
d. Amounts received or paid in respect of legal or insurance claims which were in
negotiation at the year end.
e. Determination after the year end of the sale or purchase price of assets sold or
purchased before the year end.
f. Evidence of permanent diminution in the value of a long-term investment prior to the
year end
g. Discovery of error or fraud which shows that the financial statements were incorrect.
2. Non-adjusting events, are those events that are indicative of conditions that arose after the
reporting period but will require disclosure such as the nature of the event, an estimate of its
financial effect or a statement that such an estimate cannot be made.
Examples of non-adjusting events:
a. Acquisition of, or disposal of a subsidiary after the year end.
b. Announcement of a plan to discontinue an operation
c. Major purchases and disposals of assets
d. Destruction of a production plant by fire after the reporting period
e. Announcement or commencing implementation of a major restructuring
f. Share transactions after the reporting period
g. Litigation commenced after the reporting period
Enrichment Activities:
As supplemental information, choose and watch at least one among the various
discussions/lectures on PAS 10 in YouTube.

Lesson 2.4 PAS 12: Income Taxes

PAS 12 covers both current and deferred tax. It is best to know and understand first the
following terminologies in the said standard:
Accounting profit – net profit or loss for a period before deducting tax expense. It is
computed using the PFRSs and synonymous with accounting income, financial income and
pretax income.
Taxable profit (tax loss) – the profit (loss) for the period, determined in accordance with the
rules established by the taxation authorities, upon which, income taxes are payable
(recoverable). Computed using tax laws and also known as taxable income.
Tax expense (tax income) – the aggregate amount included in the determination of net profit
or loss for the period in respect of current tax and deferred tax.
Current tax – the amount of income taxes payable (recoverable) in respect of the taxable
profit (tax loss) for a period. It is the amount actually payable to the tax authorities in relation
to the trading activities of the entity during the period.
Deferred tax – is an accounting measure, used to match the tax effects of transactions with
their accounting impact. The standard requires companies to recognize a deferred tax asset or
deferred tax liability.
Deferred tax assets – are the amounts of income taxes recoverable in future periods in respect
of deductible temporary difference, the carry forward of unused tax losses and the carry
forward of unused tax credits.
Deferred tax expense (income or benefit) – is the sum of the net changes in deferred tax assets
and deferred tax liabilities during the period.
Permanent differences – arise when income and expenses enter in the computation of either
accounting profit or taxable profit but not both. These are excluded from the income tax
return. Examples are:
a. Interest income on government bonds and treasury bills.
b. Interest income on bank deposits
c. Dividend income
d. Fines, surcharges and penalties arising from violation of law.
e. Life insurance premium on employees where the entity is the irrevocable
beneficiary.
Temporary differences – are differences between the carrying amount of an asset or liability
in the statement of financial position and its tax base, which may be either be taxable or
deductible.
Taxable temporary differences – are differences that will result in taxable amounts in
determining taxable profit (tax loss) of future periods when the carrying amount of the asset
or liability is recovered or settled. Examples are as follows:
a. Revenue is recognized in full under financial reporting but is taxable only
when collected.
b. A prepayment is capitalized and amortized to expense under financial
reporting but is tax deductible in full upon payment.
c. An asset is revalued upward and no equivalent adjustment is made for tax
purposes.
d. Depreciation recognized under financial reporting is lower than the
depreciation recognized for taxation purposes.
Deductible temporary differences – are differences that will result in amounts that are
deductible in determining taxable profit (tax loss) of future periods when the carrying amount
of the asset or liability is recovered or settled. Examples are:
a. Rent received in advance is treated as unearned income (liability) under
financial reporting but is taxable in full upon receipt of cash.
 b. Bad debts expense is recognized for financial reporting when the
collectability of accounts receivable becomes doubtful while it is tax
deductible only when the receivable is deemed worthless.
c. Warranty obligation is recognized as expense when a product is sold under
financial reporting but is tax deductible only when actually paid.
Timing differences – arise when income or an expense is included in accounting profit in one
period, but in taxable profit in a different period.
Tax base (of an asset or liability) – is the amount attributed to that asset or liability for tax
purposes. Illustrations: Indicate the tax base of the following assets and any temporary
differences arising thereto:
1. A loan receivable has a carrying amount of P1M. the repayment of the loan will have
no tax consequences.
Answer: Tax base of the loan is P1M; no temporary difference.
2. Trade receivables have a carrying amount of P100,000. The related revenue has
already been included in taxable profit.
Answer: Tax base of trade receivables is P100,000; no temporary difference.
3. Interest receivable has a carrying amount of P1,000. The relaed interest revenue will
be taxed on a cash basis.
Answer: Tax base of interest receivable is zero; temporary difference is P1,000.
4. A machine cost P10,000 and has a carrying amount of P8,000. For tax purposes,
depreciation of P3,000 has already been deducted in the current and prior periods and
the remaining cost will be deductible in future periods, either as depreciation or
through a deduction on disposal. Revenue generated by using the machine is taxable,
any gain on disposal of the machine will be taxable and any loss on disposal will be
deductible for tax purposes.
Answer: Tax base of the machine is P7,000. The temporary difference is P1,000.
5. Current liabilities include accrued expenses with a carrying amount of P2,000. The
related expense has already been deducted for tax purposes.
Answer: Tax base of accrued expenses is P2,000; no temporary differences.
6. Current liabilities include accrued expenses with a carrying amount of P1,000. The
related expense will be deducted for tax purposes on a cash basis.
Answer: Tax base of accrued expense is zero; temporary difference is P1,000.
Recognition:
1. Deferred tax liability is recognized for all taxable temporary differences except:
a. Initial recognition of goodwill
b. Initial recognition of an asset or liability in a transaction which is not a
business combination and at the time of the transaction affects neither
accounting profit nor taxable profit (tax loss)
 c. Investments in subsidiaries, branches and associates and interest in joint
arrangements to the extent that the entity is able to control the timing of the
reversal of the differences and it is probable that the reversal will not occur in
the foreseeable future.
2. Deferred tax asset is recognized for all deductible temporary differences including
unused tax losses and unused tax credits, to the extent that it is probable that taxable
profit will be available against which the deductible temporary difference can be
utilized, unless the deferred tax asset arises from the initial recognition of an asset or
liability in a transaction that is not a business combination and at the time of the
transaction, affects neither accounting profit nor taxable profit.
Measurement: Deferred tax assets and liabilities are measured at the tax rates that are
expected to apply to the period of their reversal, based on the tax rates that have been
substantively enacted by the end of the period.
Presentation:
1. Statement of Financial Position: Deferred tax assets and deferred tax liabilities are
presented separately as noncurrent assets and noncurrent liabilities respectively. The
standard permits offsetting only if:
a. The entity has a legally enforceable right to offset current tax assets
against current tax liabilities.
b. The deferred tax assets and deferred tax liabilities relate to income taxes
levied by the same taxaion authority.
2. Statement of Comprehensive Income: Tax consequences are accounted for in the
same way as the related transactions or events. Current and deferred taxes are usually
recognized in profit or loss. Examples of taxes that are recognized outside of profit
or loss:
a. Recognized in other comprehensive income:
i. Revaluation of property, plant and equipment
ii. Exchange differences arising on the translation of financial
statements of a foreign operation.
b. Recognized directly in equity:
i. Adjustment to the operating balance of retained earnings resulting
from a change in accounting policy
ii. Amounts arising on initial recognition of the equity component of a
compound financial instrument
Application:
1. In 2020, Alex Corp. had taxable profits of P120,000. In the previous year, income tax on
2019 profits had been estimated as P30,000. The corporate income tax rate is 30%. Calculate
tax payable and the change for 2020 if the tax due on 2019 profits was subsequently agreed
with the tax authorities as:
a.) P35,000 or
b.) P25,000.
Any under or over payments are not settled until the following year’s tax payment is due.
Answers:
a.) Tax due on 2020 profits (P120,000 x 30%) P36,000
Underpayment for 2019 5,000
Tax charge and liability P41,000
a.) Tax due on 2020 profits (P120,000 x 30%) P36,000
Underpayment for 2019 (5,000)
Tax charge and liability P31,000
2. In the accounting year to December 31, 2020, H Corp. made an operating profit before
taxation of P110,000. Income tax on the operating profit has been estimated as P45,000. In
the previous year 2019, income tax on 2019 profits had been estimated as P38,000 but it was
subsequently agreed at P40,500. A transfer to the credit of the deferred taxation account of
P16,000 will be made in 2020. Required:
a. Calculate the tax on profits for 2020 for disclosure in the accounts.
Income tax on profits (liability in the statement of financial position) P45,000
Deferred taxation 16,000
Under provision of tax in previous year (P40,500 – P38,000) 2,500
Tax on profits for 2020 (profit or loss charge) P63,500
b. Calculate the ta payable. P45,000