Module 06: Preparation of Financial Statement Part 1

Course Learning Outcomes:

1. General-Purpose Financial Statements
2. Purpose of Financial Statements
3. Complete set of Financial Statements
4. Overall Considerations for the Compliance with PFRS and Fair Presentation
of Financial Statement
5. Structure and Content of Financial Statements
6. Statement of Financial Position
General-Purpose Financial Statements
General Purpose Financial Statements provide financial information about the reporting entity
that is useful to existing and potential investors, lenders and other creditors in making
decisions about providing resources to the entity. Those decisions involve buying, selling or
holding equity and debt instruments, and providing or settling loans and other forms of credit.
General purpose financial statements are prepared on an accruals basis, meaning that most
transactions are recognized when the event, or performance obligation, occurs, not when
cash is paid or received. They also have the current and the preceding year to help users
better understand trends.
The statements contain four primary financial statements supported by a series of more
detailed notes, including comparing the budgeted position to the actual position. The four
primary statements are:
 Statement of Comprehensive Income
 Statement of Financial Position or Balance Sheet
 Statement of Changes in Equity
 Statement of Cash Flows
STATEMENT OF COMPREHENSIVE INCOME
This statement outlines the revenues and expenses over the year. It also includes non-cash
transactions such as depreciation, and increases or decreases in the value of assets. Most not
for-profit entities aim for a break-even position or small surplus to allow them to reinvest in
their business in future years.
STATEMENT OF FINANCIAL POSITION
The statement of financial position presents all the assets of the entity at year end, and how
they are funded, for example through liabilities and equity. Assets and liabilities are split
into current and non-current which generally means if they are expected to be settled
within 12 months.
The notes to this statement will explain how assets and liabilities are valued. For
example, whether assets are recognized at historical cost, a current market value or a
current replacement cost. The notes will also explain how a market value or a current
replacement cost is determined.
STATEMENT OF CHANGES IN EQUITY
The statement of change in equity explains what the government’s (or owner’s) interest is
comprise of. It also highlights the movement between the various classes of equity. The
most common classes for state entities are contributions by government, retained surpluses
(or deficits) and the combined increases in the value of the assets they administer.
STATEMENT OF CASH FLOWS
The statement of cash flows categories all cash payments made and received through-out
the year into three groups; operating activities, investing activities and financing activities.
Operating Activities are day to day business cash flows of the entity. Investing Activities
cover cash payments resulting from movements in assets and liabilities relating to cash
generating activities or investments in long-term service delivery assets, such as building
roads.
Financing activities are cash flows relating to how the entity is financed, it covers equity
injections, returning equity to Government and taking out or repaying long-term
borrowing.
Change of Titles
The revisions under PAS 1 includes change in the titles of the financial statements to reflect
their function more clearly.
OLD NAME NEW NAME

Balance Sheet Statement of Financial Position

Income Statement Statement of Comprehensive Income

Cash Flow Statement Statement of Cash Flows

Paragraph 81 of revised PAS 1 provides that an entity shall present all items of income and
expenses and components of other comprehensive income in either of the following:
A. Two separate statements:
 An income statement displaying the components of net income or loss.
 A statement of comprehensive income beginning with net income or loss and
displaying components of other comprehensive income.
B. Single statement of comprehensive income - Actually, this is a combined income
statement and statement of comprehensive income.
Paragraph 10 of revised PAS 1 provides that an entity may use titles for the statements
other than those in standard. Accordingly, the new names are used in accounting standards
but are not mandatory for use in financial statements. In other words, the term “balance
sheet” and “income statement” are still acceptable.
Purpose of Financial Statements
Financial statements are a structured representation of the financial position and financial
performance of an entity. The objectives of general purpose financial statements are 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 and evaluating decisions about
the allocation of resources.
Specifically, the objectives of general purpose financial reporting in the public sector
should be to provide information useful for decision making, and to demonstrate the
accountability of the entity for the resources entrusted to it by:
 Providing information about the sources, allocation and uses of financial resources;
 Providing information about how the entity financed its activities and met its cash
requirements;
 Providing information that is useful in evaluating the entity’s ability to finance its
activities and to meet its liabilities and commitments;
 Providing information about the financial condition of the entity and changes in it; and
 Providing aggregate information useful in evaluating the entity’s performance in terms of
service costs, efficiency and accomplishments
Complete Set of Financial Statements
An entity shall present with equal prominence all of the financial statements in complete set of
financial statements. Per revised Philippine Accounting Standard (PAS) No. 1, a complete set
of financial statements comprises:
1. A statement of financial position as at the end of the period.;
2. A statement of comprehensive income for the period;
3. A statement of changes in equity for the period;
4. A statement of cash flows for the period;
5. Notes, comprising a summary of significant accounting policies and other explanatory
information; and
6. A statement of financial position as at the beginning of the earliest comparative period
when an entity applies an accounting policy retrospectively or makes a retrospective
restatement of items in its financial statement or when it reclassifies items in its financial
statements.
The statement of financial position (or balance sheet) lists all the assets, liabilities and
equity of an entity as a specific date. The income statement presents a summary of the
revenues and expenses of an entity for a specific period. The statement of changes in
equity presents a summary of the changes in capital such as investment, profit or loss, and
withdrawals during specific period.
The statement of cash flows reports amount of cash received and disbursed during the
period. Accounting Policies are the specific principles, bases, conventions, rules and
practices adopted by an enterprise in preparing and presenting financial statements.
Notes to financial statements provide narrative descriptions or disaggregation of items
presented in the statement and information about items that do not qualify for recognition
in the statements.
Guidelines in the Presentation of Financial Statements
Philippine Accounting Standard 1 (PAS) gives us the following guidelines in the presentation of
financial statements.
I. Each component of the financial statements shall be clearly identified and the
following information shall be emphasized for a proper understanding of the
information presented:
 The name of the reporting entity;
 Whether the financial statements cover the individual entity or a group of
entities.
II. The period covered by the financial statement shall be specified.
Statement of Financial Position
A statement of financial position or balance sheet is a formal statement showing the three
elements comprising financial position, namely assets, liabilities and owner’s equity. Investors,
creditors and other statement users analyze the statement of financial position to evaluate
such factors as liquidity, solvency, financial structure or capacity for adaptation.
 Financial structure – is the source of financing for the assets of the enterprise. It indicates
what amount of assets has been financed by creditors, which is borrowed capital, and what
amount of assets has been financed by owners, which is invested capital.
Significance:
(1) Useful in predicting future borrowing needs and how future
profits and cash flows will be distributed among those with an
interest in the enterprise.
(2) Useful in predicting how successful the enterprise is likely to be
raising further finance.
 Liquidity – refers to the availability of cash in the near future after taking account of
financial commitments over this period.
Significance:
(1) Useful in predicting the ability of the enterprise to meet its short
term financial commitments as they fall due.
 Solvency – refers to the availability of cash over the longer term to meet financial
commitments as they fall due.
Significance:
(1) Useful in predicting the ability of the enterprise to meet its long
term financial commitments as they fall due.
Capacity for adaption – the ability of the enterprise to use its available cash
for unexpected requirements and investment opportunities. This is also
known as financial flexibility.
(1) Information about the economic resources controlled by the enterprise and
its capacity for adaptation is useful in predicting the ability of the enterprise to generate
cash and cash equivalents in the future.
Assets
Assets are defined as “resources controlled by entity as a result of past transactions
and events and from which future economic benefits are expected to flow to the
entity”.
The essential characteristics of an asset are:
a. The asset is controlled by entity.
b. The asset is the result of a past transaction or event.
c. The asset provides future economic benefits.
d. The cost of the asset can be measured reliably.
CLASSIFICATION OF ASSETS
Assets are classified in two namely current assets and noncurrent assets.
When an entity supplies goods or services clearly identifiable operating cycle, the
separate classification of current and noncurrent assets is a useful information by
distinguishing between net assets that are continuously circulating as working
capital from the net assets used in long-term operations.
The operating cycle of an entity is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents. When the the entity’s
normal operating cycle identifiable, its duration is assumed to be twelve months.
1. CURRENT ASSETS
Paragraph 66 of revised PAS 1 provides that an entity shall classify an asset as
current when:
 The asset is cash or cash equivalents unless the asset is restricted from being
exchange or used to settle a liability for at least twelve months after the reporting
figure.
 The entity holds the assets primarily for the purpose of trading.
 The entity expects to realize the assets within twelve months after the reporting
figure.
 The entity expects to realize the asset or intends to sell or consume it within the
entity’s normal operating cycle.
Presentation of Current Assets
1. Cash: is any medium of exchange that a bank will accept fore deposit at face
value. It includes coins, currency, checks, money orders, bank deposit and drafts.
2. Cash Equivalents: These are short-term, highly liquid investments that are
readily convertible to known amounts of cash and which are subjects to an
insignificant risk of changes in value.
3. Note Receivable: Is a written pledge that the customer will pay the business a
fixed amount of money on a certain date.
4. Accounts Receivable: These claims against customers arising from sales of
services or goods on credit. This type of receivable offers less security that
promissory notes.
5. Inventories: These are assets which are held for sale in the ordinary course of
business, in the process of production for such sale or in the form of material or
supplies to be consumed in the production process or in the rendering of
services.
6. Prepaid Expenses: These are expenses paid for by the business in advance. It is
an asset because the business avoids having to pay cash in the future for a specific
expense. The includes insurance and rent. These prepaid items represent future
economic benefits-assets- until the time these starts to contribute to the earning
process, these then become expenses.
2. NONCURRENT ASSETS
The caption “noncurrent assets” is a residual definition. The standard simple states
that “an entity shall classify all other assets not classified in current asset as
noncurrent.”
In other words, what is not included in the definition of current assets is is deemed
excluded. All other are classified as noncurrent assets. Accordingly, noncurrent
assets include the following:
1. Property, Plant and Equipment: These are tangible assets that are held by an
enterprise for use n the production or supply of goods or services, or for rental to
others, or for administrative purposes and which are expected to be used during
more than one period. Included are such items as land, building, machinery and
equipment, furniture and fixtures, motor vehicle and equipment.
2. Accumulated Depreciation: It is a contra account that contains the sum of the
periodic depreciation charges, The balance in this account is deducted from the cost
of the related asset-equipment or building-to obtain book value.
3. Intangible Assets: These are identifiable, nonmonetary assets without physical
substance held for use in the production or supply of goods or services, for rental to
others, or for administrative purposes. These include good will, patents, copyrights,
licenses, franchises, trademarks, brand names, secret processes, subscription lists and
non-competition agreements.
Liabilities
Liabilities are defined in the conceptual framework as “present obligations of an
entity arising from the past transaction or events, the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits.”
Liabilities are also classified as current and noncurrent.
The essential characteristics of a liability are:
 The liability is the present obligation of a particular entity. The entity liable must
be identified. It is not necessary that the payee or the entity to whom the
obligation is owed be identified.
 The liability arises from past transaction or event. This means that the liability is
not recognized until incurred.
 The settlement of the liability requires an outflow of resources embodying
economic benefits. The obligation of the entity is to transfer cash and noncash
resources or provide services at some future time.
1. CURRENT LIABILITIES
Paragraph 69 of revised PAS 1 provides that an entity shall classify a liability as
current when:
 The entity expects to settle the liability within the entity’s normal operating
cycle.
 The entity holds the liability primarily for the purpose of trading.
 The liability is due to be settled within twelve months after the reporting
period.
 The entity does not have an unconditional right to defer settlement of the
liability for at least twelve months after the reporting period.
Presentation of Current Liabilities
Under PAS 1, as a minimum, the face of the statement financial position shall
include the following line items for the current liabilities:
1. Accounts Payable: This accounts represents the reverse relationship of the
accounts receivable. By accepting the goods or services, the buyer agrees to
pay for them in the near future.
2. Notes Payable: Is like Notes Receivable but in reverse sense. In the case of
Notes Payable, the business entity is the maker of the note, that is, the
business entity is the party who promises to pay the other party a specified
amount of money on specified future date.
3. Accrued Liabilities: Amounts owned to others for unpaid expenses. This
account includes salaries payable, utilities payable, interest payable and
taxes payable.
4. Unearned Revenue: When the business entity receives payment before
proving its customers with goods or services, the amounts received are
recorded in the unearned revenue account(liability method). When the
goods or services are provided to the customer, the unearned revenue is
reduced and income is recognized.
5. Current Portion of Long-term Debt: These are portions of mortgage notes,
bonds and other long-term indebtedness which are to be paid within one
year from the balance sheet.
2. NONCURRENT LIABILITIES
The caption “noncurrent liabilities” is a residual definition. All liabilities not
classified as current are classified as noncurrent.
1. Mortgage Payable: This accounts records long-term debt of the business
entity for which the business entity has pledge certain assets as security to
the creditor. In the event that the debt payments are not made, the creditor
shall foresee or cause mortgage assets to be sold to enable the entity to settle
the claim.
2. Bonds Payable: Is a contract between the issuer and the lender specifying
the terms of repayment and the interest to be charged.
3. Deferred Tax Liability
4. Long-term Obligation to the Company Officers
5. Long-term deferred revenue
Equity
The term equity is the residual interest in the assets of the entity after deducting all of its
liabilities. Simply stated, equity means “net assets” of total assets minus liabilities.
Equity increased by profitable operations and contribution by owners. Similarly
equity is decreased by unprofitable operations and distribution to the owners. The
terms used in reporting the equity of an entity depending on the form of business are:
 Owner’s equity in a proprietorship
 Partners equity in a partnership
 Stockholders equity or shareholders equity in a corporation
However, the term equity may simple be used for all business entities. Under revised
PAS 1, the holder of instruments classified as equity are simply known as owners.
Owner’s Equity
1. Capital: This account is used to record the original and additional investments of
the owner of the business entity.
2. Withdrawals: When the owners of a business entity withdraws cash or other
assets, such are recorded in the drawing or withdrawal account rather than directly
reducing the owner’s equity account.
3. Income Summary: It is a temporary account used at the end of the accounting
period to close income and expenses. This account shows the profit or loss for the
period before closing to the capital account.
Fair Presentation and Compliance with IFRSs
The financial statements must "present fairly" the financial position, financial
performance and cash flows of an entity. Fair presentation requires the faithful
representation of the effects of transactions, other events, and conditions in accordance
with the definitions and recognition criteria for assets, liabilities, income and expenses set
out in the Framework. The application of IFRSs, with additional disclosure when necessary,
is presumed to result in financial statements that achieve a fair presentation. [IAS 1.15]
IAS 1 requires an entity whose financial statements comply with IFRSs to make an explicit
and unreserved statement of such compliance in the notes. Financial statements cannot be
described as complying with IFRSs unless they comply with all the requirements of IFRSs
(which includes International Financial Reporting Standards, International Accounting
Standards, IFRIC Interpretations and SIC Interpretations). [IAS 1.16]
Inappropriate accounting policies are not rectified either by disclosure of the accounting
policies used or by notes or explanatory material. [IAS 1.18]
IAS 1 acknowledges that, in extremely rare circumstances, management may conclude that
compliance with an IFRS requirement would be so misleading that it would conflict with the
objective of financial statements set out in the Framework. In such a case, the entity is required
to depart from the IFRS requirement, with detailed disclosure of the nature, reasons, and
impact of the departure. [IAS 1.19-21]
Preparation of Financial Position or Balance Sheet
All accounting reports require a heading which is written on the first three he
center of the report being prepared
 1st line – name of the Company
 2nd line – title of the report or statement
 3rd line – Date of the report
For income statement and Statement of Changes in Equity, the date is written as:
For the month ended for the year ended or for the six months ended. Forthe
balance sheet, the date is written as:As of ________ or just the date.
W. Kayayan Accounting Firm
Income Statement
For the month ended May 31, 2015
Service Revenue P 55,000
Less: Expenses
Office Supplies Expense
P 5,000
Salaries Expense 15,000

Utilities Expense 3,500

Telephone Expense 6,000

5,000
Interest Expense 34,500
Net Profit P 20,500
W. Kayayan Accounting Firm
Statement of Changes in Capital
For the month ended May 31, 2015
W. Kayayan, Capital Beg. P 100,000
Add: Net profit 20,500
Total 120,500
Less: W. Kayayan withdrawals 20,000
W. Kayayan, Capital End. P 100,500
Account Form

W. Kayayan Accounting Firm

Balance Sheet
May 31, 2015
Assets
Current Assets
Cash P 100,500
Accounts Receivable 20,000 Office Supplies 25,000
Total Current Assets P 150,000
Non-current Assets
Office Equipment P 50,000
Total Assets P 200,500
Liabilities and Owner’s Equity
Current Liabilities
Accounts Payable P 50,000
Notes Payable 50,000
Total Liabilities P100,000
Capital
W. Kayayan, Capital 100,500
Total Liabilities andOwner’s Equity P200,50