Framework for the Preparation and Presentation of the Financial Statements

Thomas A. Siy III

CPAR

FRSC Framework Basic concepts by which

financial statements are prepared

Sets out the concepts that underlie the preparation and presentation of financial statements for external users

Purpose of the framework

Assist the Financial Reporting Standards Council (FRSC) in developing accounting standards that represent generally accepted accounting principle

Assist the FRSC in its review and adoption of existing International Accounting Standards

Assist preparers of the financial statements in applying FRSC Statements of Financial Accounting Standards and in dealing with topics that have yet to form the subject of an FRSC statement

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Purpose of the framework

Assist auditors in forming an opinion as to whether financial statements conform with Philippine GAAP

Assist users of financial statements in interpreting information contained in the financial statements prepared in conformity with Philippine GAAP

Provide those who are interested in the work of the FRSC with information about its approach to the formulation of Statements of Financial Accounting Standards

Scope of the Framework Defines the objective of financial statements Identifies the qualitative characteristics that

make information in financial statements useful

Defines the basic elements of financial statements and the concepts for recognizing and measuring them in financial statements

Concepts of capital and capital maintenance

Limitations of the Framework Addresses general purpose financial

statements including consolidated financial statements that a business enterprise prepares and presents at least annually to meet the common information

The framework is not a standard, therefore when there is a conflict between a standard and the framework, the standard shall prevail over the framework

Users and their Information Needs

Investors - The providers of risk capital and their advisers are concerned with the risk inherent in, and return provided by, their investments. They need information to help them determine whether they should buy, hold or sell. Shareholders are also interested in information which enables them to assess the ability of the entity to pay dividends.

Employees - Interested in information about the stability and profitability of their employers. They are also interested in information which enables them to assess the ability of the entity to provide remuneration, retirement benefits and employment opportunities.

Lenders - Interested in information that enables them to determine whether their loans, and the interest attaching to them, will be paid when due.

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Users and their Information Needs Suppliers and other creditors - Interested in information that enables them

to determine whether amounts owing to them will be paid when due. Trade creditors are likely to be interested in an entity over a shorter period than lenders unless they are dependent upon the continuation of the entity as a major customer.

Customers - Interested in information about the continuance of an entity, especially when they have a long-term involvement with, or are dependent on, the entity.

Governments and their agencies - Interested in the allocation of resources and, therefore, the activities of entities. They also require information in order to regulate the activities of entities, determine taxation policies and as the basis for national income and similar statistics.

Public - Entities affect members of the public in a variety of ways. For example, entities may make a substantial contribution to the local economy in many ways including the number of people they employ and their patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the entity and the range of its activities.

Responsibility for Financial Statements

The management of an enterprise has the primary responsibility for preparing

and presenting the enterprise's financial statements.

Objectives of the Financial Statements

I. Provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.

II. Meet the common needs of most users. However, financial statements do not provide all the information that users may need to make economic decisions since they largely portray the financial effects of past events and do not necessarily provide non-financial information.

III. Financial statements also show the results of the stewardship of management.

Financial Position Factors Economic Resources that an entity controls Liquidity - Availability of cash in the near future after

taking account of financial commitments over this period

Solvency - Availability of cash over the longer term to meet financial commitments as they fall due.

Financial Structure - Useful in predicting future borrowing needs and how future profits and cash flows will be distributed among those with an interest in the entity, it is also useful in predicting how successful the entity is likely to be in raising further finance

Capacity for Adaptation - Useful in predicting the ability of the entity to generate cash and cash equivalents in the future also know as financial flexibility.

Performance of an Entity

Profitability, is required in order to assess potential changes in the economic resources that it is likely to control in the future

Information about performance is found in the income statement

Changes in Financial Position or Cash Flows

Users of financial statements seek information about the investing, financing and operating activities that an enterprise has undertaken during the reporting period. This information helps in assessing how well the enterprise is able to generate cash and cash equivalents and how it uses those cash flows. The cash flow statement provides this kind of information.

Underlying Assumptions (Postulates)

The Framework sets out two underlying assumptions of financial statements

Accrual Basis - The effects of transactions and other events are recognized when they occur, rather than when cash or its equivalent is received or paid, and they are reported in the financial statements of the periods to which they relate.  

Going Concern - The financial statements presume that an enterprise will continue in operation indefinitely or, if that presumption is not valid, disclosure and a different basis of reporting are required.

Additional Postulates The FRSC conceptual framework mentions two assumptions only.

However, it is widely believed that an inherent trait of the financial statements are the basic assumptions of:

Accounting Entity - The business is separate from the owners, managers, and employees who constitute the business. Therefore transactions of the said individuals should not be included as transactions of the business.

Time Period - Financial reports are to be prepared for one year or a period of twelve months.

Monetary Unit - There are two aspects under this assumption. First is the quantifiability of the peso, meaning that the elements of the financial statements should be stated under one unit of measure which is the Philippine Peso. Second is the stability of the peso, means that there is still an assumption that the purchasing power of the peso is stable or constant and that instability is insignificant and therefore ignored.

Qualitative Characteristics of Financial Statements

These characteristics are the attributes that make the information in financial statements useful to investors, creditors, and others. The Framework identifies four principal qualitative characteristics: a. Understandability b. Relevance c. Reliability d. Comparability

Primary Characteristics Relevance - Information in financial statements is relevant

when it influences the economic decisions of users. It can do that both by (a) helping them evaluate past, present, or future events relating to an enterprise and by (b) confirming or correcting past evaluations they have made.

Ingredients of relevance: Predictive Value – Information can help users increase the likelihood of correctly predicting or forecasting the outcome of certain events.Feedback Value – Information can help users confirm or correct earlier expectations. Note that the predictive and confirmatory roles of information are interrelated.Timeliness - Information loses its relevance if it is not timely

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Primary Characteristics Reliability - Information in financial statements is reliable if it is free from

material error and bias and can be depended upon by users to represent events and transactions faithfully. Information is not reliable when it is purposely designed to influence users' decisions in a particular direction.

Factors of reliability 

Faithful Representation – Information must represent faithfully the transactions and events it either purports to represent or could reasonably purport to represent.

 Substance over form – Transactions are to be accounted for and presented according to their substance and economic reality and not merely their legal form.

 

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Primary Characteristics

Neutrality - Information contained in the financial statements must be free from bias and error.

 Prudence (Conservatism) – The inclusion of a degree of caution in the exercise of judgments needed in making estimates or choosing alternatives so that the outcome will have the least effect on equity.

 Completeness – to be reliable, the information in the financial statements must be complete within the bounds of materiality and cost.

Constraints to Relevant and Reliable Information

Timeliness – Undue delay in reporting of information may lead to the loss of relevance even though enhancing it reliability. While providing information before all aspects of a transaction or other events are known may increase the relevance of information, thus impairing its reliability.

Balance between Benefit and Cost - The benefits derived from relevant and reliable information should exceed the cost of providing it.

Secondary Characteristics Understandability - Information should be presented in a way

that is readily understandable by users who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently.

Comparability - Users must be able to compare the financial statements of an enterprise over time so that they can identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises. Disclosure of accounting policies is essential for comparability especially when the enterprise adopts a new or changes its accounting policies.

The Elements of Financial Statements

The elements directly related to financial position and their definition according to the framework are:

Asset - An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

 Liability - A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

 Equity - Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

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The Elements of Financial Statements

The elements directly related to performance and their definition according to the framework are:

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.

 Expense - Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.

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: 1. It is probable that any future economic benefit associated with the item will flow to or from the enterprise and 2. The item's cost or value can be measured with reliability.

Specific Recognition Principles An asset is recognized in the balance sheet when it is probable that

the future economic benefits will flow to the enterprise and the asset has a cost or value that can be measured reliably.

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.

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

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.

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. The Framework acknowledges that a variety of measurement bases are used today to different degrees and in varying combinations in financial statements, including:

• Historical cost • Current cost • Net realizable (settlement) value • Present value (discounted)

Concepts of Capital

Financial concept of capital - capital is synonymous with net assets of the enterprise. This is the concept of capital adopted by most enterprises.

  Physical concept of capital – capital is

regarded as the productive capacity of the enterprise based on, for example, units of output per day.

Concepts of Capital Maintenance

Financial capital maintenance – Under this concept, a profit is earned only if the financial (or money) amount of the net assets at the end of the of the period exceeds the financial (or money) amount of the net assets at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.

  Physical capital maintenance – Under this concept, a profit is

earned only if the physical productive capacity (or operating capability) of the enterprise (or the resources need to achieve that capacity) at the end of the period exceeds the physical productive capacity at the beginning of the period, after excluding any distributions to, and contributions from, owners during the period.