MODULE 2: FINANCIAL STATEMENTS BASED ON PHILIPPINE ACCOUNTING

STANDARDS (PAS) #1
R.O. MARAMBA

OBJECTIVES:

At the end of this topic, the students will be able to:

1. Know and explain the definition and components of the financial statements
2. Know and explain the relationship of the components of financial statements
3. Prepare the basic financial statements.

Background:
Every now and then, accounting is coined as the language of finance. The reason
for this is its inherent nature of providing financial information through the formal reports
prepared by accountants. These formal reports are called financial statements. These
statements present the consequences of business events or transactions, split and
classified according to its financial nature.
According to PAS #1, an accomplished collection of financial statements would
include the following:
 Statement of Financial Position (Balance Sheet)
 Income Statement
 Statement of Comprehensive Income
 Statement of Change in Equity
 Statement of Cash Flows
 Notes to the Financial Statements

The same PAS made changes in the titles of financial statements in order to mirror
their specific functions. The income statement presents the report on income and
expenses; the statement of cash flows presents the movement of cash to and from the
company. The balance sheet's name is changed to statement of financial position
because; the word balance sheet does not reflect what is found in the statement. A
balance of what, hence the change of the name. The statement of financial position is a
better name since it tells the user what can be found in the report.
The financial statements' foremost objective is to provide information concerning
the financial position, performance and cash flows of a company needed by various
users in making sound economic decisions.

STATEMENT OF FINANCIAL POSITION (SFP)

As the name connotes, this financial statement present the company's financial
position at a given period. It consists of the three elements making up the financial
position - assets, liabilities and equity.
 Users of this statement, current as well as potential investors, current as well as
potential creditors, and the firm's management, utilize it in evaluating the company's
liquidity, solvency, financial structure, and capacity for adaptation.

Assets and their Classification

The definition of assets includes its essential features. Assets are "resources
controlled by the entity as a result of past transactions and events from which future
economic benefits are expected to flow in the entity." For assets to be recognized for
recording, the cost of the asset should be measured reliably.

Classification:

1. Current Assets. Assets are considered to be current when:

 it is cash or cash equivalent
 when the company intends to hold the asset for the purpose of trading it
 when the company expects to realize the asset within 12 months
 when the company expects to realize the asset or intends to sell or use it
within the entity's normal operating cycle.

The current assets are typically arranged in the order of liquidity. The line items
in the current assets can be seen in the sample SFP in this chapter.

2. Non-current Assets take the residual definition. This means that if the asset
does not fall under current asset then it must be non-current.

Liabilities and their Classification

The firm's liabilities are the present obligations of the firm from past transactions or
events, the payment of which is expected to result in an outflow of economic resources
or assets.

Classification:
1. Current Liabilities – one of the criteria for one to classify liabilities as current is
when the firm is expected to pay the liability within its normal operating cycle.
Another criteria is when the firm holds the liability primarily for the purpose of
trading, also when the liability can be paid within twelve months.
2. Non-current Liabilities - also take the residual definition. Liabilities not classified
not as current are non-current. The presentation of the current and non-current
liabilities is also found in the same SFP.
Shareholders' Equity (SHE) and its Components

The shareholders' equity or simply Equity in its raw meaning is the excess of the
firm's assets over the firm's liabilities. The shareholders' equity of a corporation has
three basic components, namely the share capital, reserves and retained earnings.

Share capital component of the SHE consists of the issuance of the company's
own share at their par or stated value.

The reserves component consists of issuance of the company's own share above
par/stated value or additional paid in capital or sometimes called premium on share
capital. The other reserve component may consist of various comprehensive incóme,
revaluation surplus, and appropriated retained earnings.

The last component of the SHE is the Retained Earnings. This component
consists of, among other things, the accumulated earnings of the company, prior period
adjustment for errors, dividends declared/paid, effect of changes in accounting policy
and appropriated retained earnings. The components of the SHE are presented in the
statement of changes in equity.

INCOME STATEMENT AND ITS FORMS

This statement presents the result of the firm's operation or performance for a
given time. Elements found in the statement consist of revenue and expenses. In the
provisions of PAS #1, it mentioned that a business should present the income statement
by using either the functional approach (cost of sales method) or natural approach.

The functional presentation follows the function of expenses, while the natural
approach considers the nature of expense. Under the functional approach the expenses
are classified in accordance with their function namely, cost of sales, selling expenses,
administrative expenses and other expenses. This is the typical income statement
format used by most companies.

The expenses under the natural approach are clustered according to their nature.
All revenue items are clustered and totaled. All expenses are clustered and totaled. The
sum of the expenses are deducted from the sum of revenues to get the income before
tax.

STATEMENT OF COMPREHENSIVE INCOME

Generally, comprehensive income consists of recognized gains and losses that

are not included in the income statement but are found in the equity section of the SFP
or more clearly at the statement of changes in equity.
 The statement of comprehensive income can be presented separately or can be
presented as an extension of the income statement. When the comprehensive income
is included in the income statement, the income statement heading is no longer used.
Instead, the income statement shall be called statement of comprehensive income.

STATEMENT OF RETAINED EARNINGS

The results of the current year's operation bring about changes in the company's
retained earnings. These changes are disclosed in the statement of retained earnings.
This statement link the income statement results to the SFP.

It is however important to note that this statement is no longer required to be

prepared separately. This is because the statement of changes in equity includes the
components of the statement of retained earnings.

STATEMENT OF CHANGES IN EQUITY

The developments or changes that occur in the shareholders' equity are presented in
the statement of changes in equity. The following are presented in this statement:

1. The total or net comprehensive income.

2. Effects brought about by the changes in accounting policies or correction of
errors.
3. Investment transactions of owners and dividends paid to owners.
4. The beginning balance of each component in the statement of changes in equity
and the movements under them that brought about the ending balances.

These concepts are made clear by observing the statement of changes in equity
sample.

STATEMENT OF CASH FLOW (Based on PAS 7)

The summary of the operating, investing and financing activities of the firm is
presented in the statement of cash flows. This statement reconciles the beginning and
ending balances of cash and cash equivalents in the SFP. The ending balance of the
statement of cash flows is the same as the cash balance presented in the balance
sheet. In other words, this statement shows the movements (receipts and
disbursements) of cash for one whole period, generally one year.

Cash flows and its Classification

Cash flows refer to the movement of cash. It could either be an inflow of cash,
which pertains to receipts of cash or an outflow, which means disbursement of cash.
 In presenting the cash flow for the period, the movement of cash shall be
categorized as cash flows from:

1. Operating activities. These are activities related in the generation of the

principal revenue of the firm. Principal revenue means the main source of
revenue or income for the company. For instance, selling activities are the
principal source of revenue of merchandising firms. Therefore, cash sales is a
source of cash inflow from operating activities. Among the other examples of
cash flows from operating activities may include:
 Cash receipts from rental fees, service fee, professional fees, legal fees,
tuition fee, etc.
 Cash used to pay salaries, utilities, purchases, and payables.
 Cash receipts or disbursement from securities kept by the company for
dealing or trading. They are like merchandise held for sale.
2. Investing activities. These are cash flows from purchasing or selling long-term
assets and other long-term investments. Basically, these are cash flows from
sale or purchase transactions wherein non-operating assets (assets other than
inventory) are involved.
 Cash disbursements used to buy buildings, plants, equipment, furniture
and other fixed assets.
 Cash receipts or payments from derivative transactions like future or
forward contracts, swap contracts and option contracts.
 Cash receipts or payments from selling or buying of equity securities or
shares or debt instruments like bonds of other companies for short-term or
long-term purposes.
3. Financing activities. These are the company's cash inflows or outflows
involving its owners (equity financing) and creditors (debt financing). The
borrowings included under this category are non-trade payables. Non-trade
payable are those we get from borrowings from bank or other financial
institutions. These are not from purchases of inventory or company office or store
supplies. Examples of these activities include:

 Cash receipts from issuance of the company's ordinary shares, and

preferred shares.
 Cash disbursements used to pay acquisition of treasury shares or
redeemable preferred shares.
 Cash receipts from issuing the company's bonds or notes.
 Cash receipts from short-term or long-term loans payable, bank payables,
or mortgage payables
 Cash disbursement used to pay bank loan and other form of borrowings.
ILLUSTRATIVE EXAMPLE:

The consolidated financial statements provided here, is industry-based. It is

taken from a world-renowned corporation belonging to the fuel industry. The accounts
are industry-based; however, the amounts are assumed figures. It is important to
remember that financial statements may vary from one industry to another.
Consolidated financial statements, as the name connotes, is a consolidation of financial
statements made by a firm with subsidiaries. Subsidiaries are Independent Corporation
that holds controlling ownership over its subsidiaries.
 NOTES TO THE FINANCIAL STATEMENTS

There are bits or set of information that cannot be disclosed on the face of the
financial statements. This information may be either quantitative or qualitative in nature
and may have a bearing on how the financial statements may be interpreted. Since they
are not found on the face of the financial statements and have a bearing in interpreting
the financial statements, they are placed to the notes to the financial statement section
of the auditor's report.

The notes may include (indicated as a subheading) the following:

 Corporate/Company Information. This may include the nature of the business,

the associates or subsidiaries of the company, and the principal activities of the
company.
 Basis of Preparing the Financial Statements and the Statement of
Compliance (when segregated from the Summary of Significant Accounting
Policies). The basis in preparing the financial statements could be at historical
cost or at fair value. The preparation of the financial statements should comply
with the Philippine Financial Reporting Standards (PFRS).
 Summary of Significant Accounting Policies. The significant accounting
policies used by the company in carrying out their operations and preparing their
financial statements. The changes in accounting policies may also be included
here or placed in a segregate heading. The breakdown of the line items in the
financial statements is also included under this subheading. For example, the
Trade and Other Receivables in the face of the SFP is broken down in detail and
the total is the one shown in the SFP.

The main objective for preparing the notes is to supply the users of the financial
statements the necessary disclosures as required by the Philippine Financial Reporting
Standards (PFRS).

Presented below are selected portions of the notes to the financial statement. This
would give you an idea on what the notes contain.
Excerpts from the Notes to Financial Statements (ADA Corporation)

Corporate/ Company Information:

The firm was incorporated under the laws of the Republic of the Philippines and
registered with the Philippine Securities and Exchange Commission (SEC) on July 22,
1966. ADA is considered the largest oil refining and marketing company in the
Philippines. It supplies more than 1/3 of the nation's fuel requirements.

Basis of Preparing the Financial Statements:

The accompanying financial statements of ADA Corporation and subsidiaries were
prepared on a historical cost basis, except for the financial assets, available-for-sale
(AFS) investments and derivative financial instruments, which are measured at fair
value. The consolidated financial statements are presented in Philippine peso, which is
the firm's functional and presentation currency. All amounts are rounded to the nearest
millions, except when otherwise indicated.

Statement of Compliance
The consolidated financial statements of the firm were prepared in compliance with
Philippine Financial Reporting Standards (PFRS).