Accrual Basis

An entity shall prepare the financial statements, except for cash flow
information, using the accrual basis of accounting.

Under accrual basis, the effects of transactions and other events are
recognized when they occur and not as cash or cash equivalent is
received or paid, and they are recorded and reported in the financial
statements of the periods to which they relate.
In the simplest language, accrual basis means that assets are
recognized when they are receivable rather than when physically
received, and liabilities are recognized when they are payable rather
than when actually paid.

Accrual accounting means that income is recognized when earned

regardless of when received and expense is recognized when
incurred regardless of when paid.

The essence of accrual accounting is the recognition of accounts

receivable, accounts payable, prepaid expenses, accrued expenses,
deferred income, and accrued income.
 Materiality and Aggregation

An entity shall present separately each material class of similar

items.
An entity shall present separately items of dissimilar nature or
function unless they are immaterial.
Financial statements result from processing large number of
transactions or other events that are aggregated into classes
according to their nature or function.

The final stage in the process of aggregation and classification

is the presentation of condensed and classified data which form line
items in the financial statements.
For example, cash on hand, petty cash fund, cash in bank,
and cash equivalents shall be presented as one item “cash
and cash equivalents”.

Finished goods, goods in process, raw materials and

manufacturing supplies are aggregated and presented as
one item “inventories”.
If a line item is not individually material, it is aggregated with
other items either in those statements or in the notes.

For example, an investor’s share in the net income of an associate is

presented as a separate line item in the income statement.

However, if this amount is not individually material, it may be

aggregated with other income.
Materiality dictates that “an entity need not provide a specific
disclosure required by PFRS if the information is not material”.
 When is an item material?

There is no strict or uniform rule for determining whether an item is

material or not.
Very often, this is dependent on good judgment, professional expertise and
common sense.

However, a general guide may be given, to wit:

o An item is material if knowledge of it would affect the decision of the
informed users of the financial statements.
o Information is material if the omission or misstatement could
influence the economic decision that users make on the basis of the
financial statements.
 For example, small expenditures for tools are often expensed
immediately rather than depreciated over their useful life to save on
clerical costs of recording depreciation.
In such a case, the effect on the financial statements is not large
enough to affect the economic decision.

Another example is the common practice of large entities of

rounding amounts to the nearest thousand pesos in their financial
statements.

Small entities may round off to the nearest peso.

 Materiality is a relativity

Materiality of an item depends on relative size rather

than absolute size. What is material for one entity may
be immaterial for another.

An error of P100,000 in the financial statements of a

multinational entity may not be important but may be so
critical for a small entity.
 Factors of Materiality
In the exercise of judgment in determining materiality, the following factors
may be considered:

a. Relative size of the item in relation to the total of the group to which the item
belongs.
For example, the amount of advertising in relation to total distribution costs, the
amount of office salaries to total administrative expenses, the amount of prepaid
expenses to total current assets and the amount of leasehold improvements to
total property, plant and equipment.

b. Nature of the item – An item may be inherently material because by its very
nature it affects economic decision.
For example, the discovery of a P20,000 bribe is a material event even for a
very large entity.