FAR 3 ESRL & JPRF

CONCEPTUAL FRAMEWORK
PURPOSE AND STATUS OF THE FRAMEWORK
The FRSC Framework for the Preparation and Presentation of Financial Statements describes the
basic concepts by which financial statements are prepared. The Framework serves as a guide to the
Board in developing accounting standards and as a guide to resolving accounting issues that are not
addressed directly in Philippine Accounting Standards or Philippine Financial Reporting Standards or
Interpretations. The purpose of the framework as outlined is to:
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;
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;
and
Defines the basic elements of financial statements and the concepts for recognizing and
measuring them in financial statements.
Concepts of capital and capital maintenance.
General Purpose Financial Statements
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 needs of a wide range of users external to the enterprise. Therefore, the Framework
does not necessarily apply to special purpose financial reports such as reports to tax authorities,
reports to governmental regulatory authorities, prospectuses prepared in connection with securities
offerings, and reports prepared in connection with business combinations.
Users and their Information Needs
The principal classes of users of financial statements are present and potential investors, employees,
lenders, suppliers and other trade creditors, customers, governments and their agencies and the
general public. All of these categories of users rely on financial statements to help them in decision
making.
While financial statements cannot meet all of the information needs of these user groups, there are
information needs that are common to all users, and general-purpose financial statements focus on
meeting these needs.

Responsibility for Financial Statements

The management of an enterprise has the primary responsibility for preparing and presenting the
enterprise's financial statements.
The Objective of Financial Statements
The objective of financial statements is to 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.

Financial Position
The financial position of an enterprise is affected by the economic resources it controls, its financial
structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which
it operates. The balance sheet presents this kind of information.
Performance
Performance is the ability of an enterprise to earn a profit on the resources that have been invested
in it. Information about the amounts and variability of profits helps in forecasting future cash flows
from the enterprise's existing resources and in forecasting potential additional cash flows from
additional resources that might be invested in the enterprise. The Framework states that information
about performance is primarily provided in an 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 the 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.
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

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.
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

Financial statements portray the financial effects of transactions and other events by grouping them
into broad classes according to their economic characteristics. These broad classes are termed 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.

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:
It is probable that any future economic benefit associated with the item will flow to or from
the enterprise; and
The item's cost or value can be measured with reliability.
Based on these general criteria:

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)
Historical cost is the measurement basis most commonly used today, but it is usually combined with
other measurement bases. The Framework does not include concepts or principles for selecting
which measurement basis should be used for particular elements of financial statements or in
particular circumstances. The qualitative characteristics do provide some guidance in this matter.

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.
ACCRUALS/CASH BASIS & SINGLE ENTRY
CASH BASIS ACCRUAL BASIS
SALES Cash Sales + Collection Cash Sales + Sales on
Account
PURCHASES Cash Purchases + Payments Cash Purchases + Purchase
on Account
INCOME Received Received + Earned
EXPENSES Paid Paid + Incurred
DEPRECIATION Provided Provided
BAD DEBTS x /

COMPUTATION OF SALES
Sales
SRA Cash Sales
SDA Sales on Account

Accounts Receivables
Beginning, A/R Collections
Sales on Account SRA / SDA
Written off
Discounted (N/R
Credited)
End, A/R

COMPUTATION OF PURCHASES
Purchases
Cash Purchases PRA
Purchase on Account PDA

Accounts Payable
Payments Beg, A/P
PRA / PDA Purchases on Account
End, A/P

INCOME OTHER THAN SALES

Cash Basis P xx
Deferred Income, beg xx - received last year, will be earned this year
Accrued Income, end xx - earned this year, will be received next year
Deferred Income, beg ( xx ) - received this year, will be earned next year
Accrued Income, end ( xx ) - earned last year, will be received this year
Accrual Basis P xx
EXPENSES IN GENERAL

Cash Basis P xx
Prepaid Expenses, beg xx - paid last year, will be incurred this year
Accrued Expenses, end xx - accrued this year, will be paid next year
Prepaid Expenses, beg ( xx ) - paid this year, will be incurred next year
Accrued Expenses, end ( xx ) - incurred last year, will be paid this year
Accrual Basis P xx

SINGLE ENTRY METHOD

- Net Asset Approach or Capital Maintenance Approach

PROPRIETORSHIP/ PARTNERSHIP
Capital, end P xx
Withdrawals xx
Capital, beg xx
Additional Investment ( xx )
Net Income(Loss) P xx

CORPORATION
Retained Earnings, end P xx
Dividends declared/paid xx
Retained Earnings, beg ( xx )
Net Income(Loss) P xx

PPE
Beg, PPE Carrying Amount
(Sold)
Cost ( Acquired) Depreciation
Expenses
End, PPE

COMPUTATION OF COST OF SALES/ COST OF GOODS SOLD

Merchandise Inventory, beg P xx
Purchases xx
Merchandise Inventory, end ( xx )
Cost of Sales / CGS P xx

NOTE:
*All INCREASES are ADDED; all DECREASES are DEDUCTED
Except: in
Inventory - computation of CGS
PPE - computation of Depreciation
Prepaid Expenses - computation of Expenses in General
Deferred Income - computation of Income other than Sales
ERRORS AND THEIR CORRECTION

Legend: C = Correct; U = Understated; O = Overstated

Summary of Errors and their EFFECTS on profit

Effect on Profit
Type of Counterbalancing Error
Current Yr. Next Yr.
A. Ending Inventory
Overstated Ending Inventory O U
Understated Ending Inventory U O

B. Accrued Expense
Failure to Accrue Expense (Understated) @ year end O U
Overstated Accrued Expense @ year end U O

C. Accrued Revenue
Failure to Accrue Revenue (Understated) @ year end U O
Overstated Accrued Revenue @ year end O U

D. Prepaid Expense
Overstated Prepaid Expense @ year end O U
Understated Prepain Expense @ year end U O
E. Unearned Revenue (Liability For Revenue Received in
Advance)
Understated Unearned Revenue @ year end O U
Overstated Unearned Revenue @ year end U O

The Summary Expanded

A. Ending Inventory
Overstated Understated
Beginning Inventory C C
Purchases C C
Cost of Goods Available for Sale C C
Ending Inventory (O) (U)
Cost of Sales U O

Sales C C
Cost of Sales (U) (O)
Gross Profit O U
Revenues C C
Expenses (C) (C)
Net Income, Current Year O U
B. Accrued Expense (Incurred but not yet paid; Liability)

Adjusting Entry @ year end

Expense xxx
Accrued Expense xxx
Understated
/
Failed to
record or Overstated

Gross Profit C C
Revenues C C
Expenses (U) (O)
Net Income O U

C. Accrued Revenue (Earned but not yet received/collected;

Asset)

Adjusting Entry @ year end

Receivable xxx
Revenue xxx

Understated
/ failed to
record or
accrue Overstated

Gross Profit C C
Revenues U O
Expenses (C) (C)
Net Income U O

D. Prepaid Expense (Already paid but not yet incurred; Asset)

Adjusting Entry @ year end

Expense xxx
Prepaid Expense xxx
Overstated /
Failed to
record or
Understated accrue

Gross Profit C C
Revenues C C
Expenses (O) (U)
Net Income U O
E. Unearned Income (Already received but not yet earned;
Liability)

Adjusting Entry @ year end

Unearned Revenue xxx
Revenue xxx
Overstated /
Failed to
record or
Understated adjust

Gross Profit C C
Revenues O U
Expenses (C) (C)
Net Income O U

Additional Information
A. Beginning Inventory

Beginning Inventory O U
Purchases C C
Cost of Goods Available for Sale O U
Ending Inventory (C) (C)
Cost of Sales O U

Sales C C
Cost of Sales (O) (U)
Gross Profit U O
Revenues C C
Expenses (C) (C)
Net Income, Current Year U O

B. Revenues and Expenses in General

REVENUES
Overstated Understated
Gross Profit C C
Revenues O U
Expenses (C) (C)
Net Income, Current Year U O
Expenses (O) (U)
Net Income, Current Year U O
Note:
SFP and Income Statement errors usually require restatement only.
Steps for reclassification:
1. Reverse the erroneous entry.
2. Make the correct entry
(May be done in a single compound entry

noncounterbalancing errors do not correct themselves and require correcting entries.