FINANCIAL STATEMENTS

Purpose of financial statements:

Financial statements are a structured representation of the financial position and financial performance of
an entity. The objective of financial statements is to provide information about the financial position, financial
performance and cash flows of an entity that is useful to a wide range of users in making economic decisions.
Financial statements also show the results of the management stewardship of the resources entrusted to it. To meet
this objective, financial statements provide information about an entity's (a) assets (b) liabilities (c) equity (d)
income and expenses, including gains and losses (e) contributions by and distributions to owners in their capacity as
owners and (f) cash flows. This information, along with other information in the notes, assists users of financial
statements in predicting the entity's future cash flows and, in particular, their timing and certainty.

Statement of Financial Position depicts the financial position of a business entity and is affected by 1) the
economic resources it owns and controls, 2) its financial structure and 3) its liquidity and solvency. It presents the
resources (assets), obligations (liabilities) and equity at a given point in time. There are two forms used: Account
Form, which follows the equation where assets are listed on the left hand column of the report with the liabilities
and equity listed on the right hand column; and Report Form that is shown in one straight column the assets
followed by the liabilities and equity.

Elements of Statement of Financial Position

Assets – are resources controlled by the entity as a result of past events and from which future economic benefits are
expected to flow to the entity. These are 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.

Liabilities – are present obligations of the entity arising from past events, the settlement of which are expected to
result in an outflow from the entity of resources embodying economic benefits. These are 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.

Equity – is the owners’ residual interest in the assets of an entity that remains after deducting its liabilities.

Current and Non-Current Classification:

Assets and liabilities should be separately classified on the face of the balance sheet except in circumstances when a
liquidity-based presentation provides more reliable and relevant information.

Current asset - IAS/PAS 1, paragraph 66: An entity shall classify an asset as current when:

a. It expects to realize the asset or intends to sell or consume it, in its normal operating cycle;

b. It holds the asset primarily for purpose of trading.

c. It expects to realize the asset within twelve months after the reporting period; or

d. The asset is cash or cash equivalent unless the asset is restricted from being exchanged or used to settle a liability
for at least twelve months after the reporting period.

An entity shall classify all other assets as non-current.

Current liabilities – IAS/PAS 1, paragraph 69: An entity shall classify a liability as current when:

a. It expects to settle the liability in its normal operating cycle;

b. It holds the liability primarily for the purpose of trading;

c. The liability is due to be settled within twelve months after the reporting period; or

d. The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after
the reporting period.
An entity shall classify all other liabilities as non-current.

Working Capital. An entity’s liquidity is the primary concern to most statement users and this can be properly
evaluated through the current and non-current classifications. Working capital is the excess of current assets over
current liabilities.

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Income Statement (Statement of profit or loss) shows the financial performance of the entity. This shows how
well the business entity performed by listing down the revenues earned and expenses incurred.

Forms of Presenting the Statement of Profit or loss and other comprehensive income:

1. Functional presentation – also known as cost of sales method, this form classifies expenses according to
their function as part of cost of sales, selling activities, administrative activities and other activities. At a
minimum, an entity discloses its cost of sales under this method separately from other expenses. This is
commonly used for merchandising and manufacturing businesses.
2. Natural presentation – also known as nature of expense method, this form, expenses are aggregated
according to their nature and not allocated among various functions within the entity. (for example,
depreciation, purchase of materials, transport costs, employee benefits, and advertising costs), and are not
reallocated among various functions within the entity. This form which is called the single step form makes
a single step of deducting the total expense from the total revenues to arrive at the profit or loss. Service
companies commonly use this type of presentation.

Statement of Changes in Equity (Capital statement) explains what happened to the capital or claim of the owner.
Equity is defined as the residual interest in the assets of an entity after deducting all of the liabilities. In other words,
equity is the equivalent of net assets.

Statement of Cash Flows is a component of financial statements summarizing the operating, investing and
financing activities of an entity. This is important as the information given in this statement is useful in assessing the
ability of the entity to generate cash. Cash flows are vital to the financial health of the business. Too little or too
much cash will affect the smooth flow of the financial operation. Revenues should easily be converted into cash so
that disbursements could easily be paid. Some businesses fail because of its inability to maintain proper balance
between receipts and disbursements. It is good for a business to generate cash from operation much more than from
financing or investing activities.

Cash flows are inflows (source or receipts) and outflows (disbursements) of cash. Classification by activity provides
information that allows the users to assess the impact of those activities to the other financial statements of the
entity.

1. Operating Activities – cash flows derived primarily form the principal revenue producing activities of the
entity. These generally results from transactions and other events that enter into the determination of net
income or loss.
2. Investing Activities – derived from the acquisition and disposal of long term assets and other investments.
3. Financing Activities – derived from the equity capital and borrowings of an entity. Inflows come from
loans extended by creditors and cash contributions made by investors or owners, outflows are the cash paid
to creditors and withdrawal of owners.

Theories.

1. Financial statements must be prepared at least

a. Annually
b. Quarterly
c. Semiannually
d. Every two years
2. Which of the following does not describe a current asset?
a. It is held primarily for the purpose of being traded
b. It is expected to be realized within twelve months after the balance sheet date.
c. It is a cash or a cash equivalent restricted for more than 12 months from the balance sheet date.
d. It is expected to be realized, sold or consumed within the entity’s normal operating cycle.
3. The term “net assets” represents
a. Current assets less current liabilities
b. Owner’s equity
c. Net income

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 d. Total assets less total liabilities
4. The operating cycle concept
a. Causes current and non-current items to depend on whether they will affect cash within one year.
b. Permits an asset to be classified as current even if takes more than one year for it to be converted to
cash.
c. Has become obsolete.
d. Affects the income statement.
5. If the operating cycle of a business is fifteen months
a. Cash set aside for the purchase of an equipment will be shown as a current asset
b. Non-trade receivable that is due in one year and two months from the balance sheet date will be shown
as a current asset.
c. Trade receivable that is due in 14 months from the balance sheet date will be shown as a current asset.
d. A note that is payable by the business two years from the balance sheet date will be shown as current
liability.
6. The amount of time that is expected to elapse until an asset is realized or otherwise converted into cash is
referred to as a. Solvency
b. Financial flexibility
c. Liquidity
d. Exchangeability
7. The correct order to present current assets is
a. Cash, inventories, prepaid items, accounts receivable
b. Cash, inventories, accounts receivable, prepaid items
c. Cash, accounts receivable, prepaid items, inventories
d. Cash, accounts receivable, inventories, prepaid items
8. Accrued revenue would normally appear in the statement of financial position under a. Non-current assets
b. Current liabilities
c. Non-current liabilities
d. Current assets
9. Cash receipts from fees, revenues, commissions and other revenues are
a. Cash outflows for operating activities
b. Cash inflows from operating activities
c. Cash inflows from investing activities
d. Cash outflows from financing activities
10. The income statement shows information about an entity’s
a. Liquidity
b. Performance
c. Cash flow
d. Financial structure