ACCOUNTING RECOGNITION OF INCOME

 Income is recognized in the statement of

Chapter 3 comprehensive income when an increase in
Statement of Comprehensive Income (income future economic benefit related to an increase in
statement) – structured financial statement that shows an asset or a decrease in a liability has arisen,
the financial performance of a business entity for a given which can be measured reliably. Generally, an
period. income is recognized when revenue has been
earned where it can be measured reliably and
Income – refers to increases in economic benefits during has some sufficient degree of certainty.
the accounting period in the form of inflows of
enhancement of assets or decreases of liabilities that RECOGNITION OF EXPENSES
result in increases in equity other than those relating to  Expenses are recognized in the income
contributions from equity participants. statement when a decrease in future economic
Expenses – refers to decreases in economic benefits benefits related to a decrease in assets or an asset
during the accounting period in the forms of outflows or in liabilities has arisen, which can be measured
depletion of assets or incurrences of liabilities that reliably.
results in decreases in equity other than those relating to METHODS OF RECOGNIZING EXPENSES
distribution to equity participants.
 MATCHING COSTS WITH REVENUES –
Differences between Statement of Financial Position and Expenses are recognized in the statement of
Statement of Comprehensive Income comprehensive income on the basis of a direct
 STATEMENT OF FINANCIAL POSITION association between costs incurred and the
- Assets, Liabilities, Equity earning of specific items of income. (Ex. Cost of
- Presents the financial position Goods Sold)
- Liquidity, solvency, financial structure, and  SYSTEMATIC AND RATIONAL
capacity for adaptation ALLOCATION – This allocation procedure is
- As of a given date (one day only, annually) intended to recognize expenses in the accounting
- Real accounts periods in which the economic benefits
associated with the item is consumed or expired.
 STATEMENT OF COMPREHENSIVE
(PPE, Used Supplies, Goodwill, Patents or
INCOME
Trademarks – depreciation/amortization)
- Income and expenses
 IMMEDIATE RECOGNITION – An expense
- Presents the result of operation
is recognized immediately in the statement of
- Profitability of the business entity
comprehensive income when expenditure
- For a given period (monthly, quarterly,
produces no future benefits or when the future
semi-annually, or annually)
economic benefits do not qualify for recognition
- Nominal accounts
in the statement of financial position as an asset.
Recognition Principle – process of incorporating in the
DETERMINATION OF PROFIT
statement of comprehensive an item that meets the
definition of income and expense that satisfies the PROFIT is frequently used as a measure of performance
criteria for recognition. or as the basis for other measures such as return on
investment or earnings per share.
An item should be recognized if:
PROFIT/NET INCOME is generally the expression for
1. It is probable that any future economic benefit
the financial performance of a business entity.
associated with the item will flow to or from the
entity Two Methods of Determining the Net Income or Profit
2. The item has a cost or value that can be of Business Entity
measured with reliability.
 CAPITAL MAINTENANCE APPROACH –
NOTE: The failure to recognize an income or expense is concerned with how an entity defines the capital
not rectified by disclosure of the accounting policies it seeks to maintain; only inflows of assets in
used or by notes or explanatory materials.
 excess amounts needed to maintain capital may 1. Increase in assets will increase net assets
be regarded as profit. NOTE: Profit under this 2. Decrease in assets will decrease net assets
approach is measured by simply comparing the 3. Increase in liability will decrease net assets
capital at the end of the period against the capital 4. Decrease in liability will increase net assets
at the beginning of the period.
Methods of Presenting the Statement of Comprehensive
- CAPITAL (excess of assets over liabilities
Income
or net assets)
- Two Concepts of Capital Maintenance: (1) PAS 1 mentions 2 methods of presenting the statement
FINANCIAL CAPITAL of comprehensive income. The choice between the
MAINTENANCE – A profit is earned only nature of expense method and the function of expense
if the financial amount of the net assets at method depends on historical and industry factors and
the end of the period exceeds the financial the nature of the entity.
amount of net assets at the beginning of the
period and excluding any distributions to Information on the nature of expense is useful in
and contributions from owners during the predicting the future cash flow, additional disclosure is
period. required when the function of expense classification is
- PROFIT represents the increase in nominal used.
money capital over the period.
 NATURE OF EXPENSE METHOD (the
- Measured using the HISTORICAL COST expenses are aggregated in the statement of
- (2) PHYSICAL CAPITAL
comprehensive income according to their nature.
MAINTENANCE – A profit is earned only Ex: depreciation, purchases of materials,
if the physical productive capacity of the
transport costs, employee benefits, and
entity at the end of the period exceeds the advertising costs. This method may be simple to
physical productive capacity at the
apply because no allocations of expenses to
beginning of the period after excluding any functional classifications are necessary.)
distributions to and contributions from
 FUNCTION OF EXPENSE OR COST OF
owners during the period.
SALES METHOD (expenses are classified
- PROFIT represents the increase in that
according to their function as part of cost of
capital over the period.
sales, distribution, or administrative activities;
- Measured using the CURRENT COSTS
this method can provide more relevant
 TRANSACTION APPROACH – traditional
information to users than the classification of
method of determining net income or profit in expense by nature, but allocating costs to
accordance with the PAS.
functions may require arbitrary allocation and
- INCOME encompasses both revenues and involve considerable judgment.)
gains. REVENUES arise in the course of
the ordinary activities of an entity. GAINS DISCLOSURE OF INFORMATION ON THE
represent other items that meet the definition STATEMENT OF COMPREHENSIVE INCOME
of income and may or may not arise in the
Note: All items of income and expenses recognized in a
course of the ordinary activities (disposal of
period shall be included in profit or loss unless a
noncurrent assets). Gains are often reported
Standard or an Interpretation requires otherwise.
in the income statement net of related
expenses. The following items are excluded from profit or loss:
- EXPENSES encompass losses as well as
those expenses that arise in the course of the 1. Revaluation surplus
ordinary activities of the entity; usually take 2. Gains and losses on translating the financial
the form of an outflow or depletion of statements of a foreign operation
assets, unrealized losses (when an asset 3. Gains or losses on remeasuring available-for-
remains unsold after it has decreased in sale financial assets
price). LOSSES represent decreases in 4. Correction of errors
economic benefits. If expenses exceed 5. Effects on changes in accounting policies
income, the residual amount is called LOSS.
Remember the following points:
Chapter 4 Foreign currency translation reserve arises from the
translation of financial elements or transactions in
Equity is the residual interest in assets of the entity after foreign currency.
deducting all its liabilities.
STATEMENT OF CASH FLOWS
Statement of changes accounts for changes on the
- It is a financial statement that provides
equity of the owner. It is a financial statement showing
information about the historical changes,
on the face of the statement of the following:
inflows and outflows, and in cash and cash
1. Net income or loss for the period equivalents of an entity during the period
2. Each item of income and expense for the period from operation, investing, and financing
that is recognized directly in equity and the total activities
of these items
Cash comprises cash on hand and demand deposits.
3. Total income and expense for the period
showing separately total amounts attributable to Cash equivalents are short-term, highly liquid
equity holders of the parent and to minority of investments that are readily convertible to known
interest amounts of cash and are subject to an insignificant risk
4. For each component of equity of changes in value.
The statement of changes of a sole proprietorship and Operating activities are the principal revenue-
a partnership is usually affected by net income or loss producing activities of the entity and other activities that
during the period, additional investment, and withdrawal are not investing or financing activities.
of capital.
 The amount of cash flows arising from operating
For a corporate entity, the equity of the shareholders in activities is a key indicator of the extent to
the statement of financial position may be subclassified which the operations of the entity have
as share capital, retained earnings, and reserves. generated sufficient cash flows to repay loans,
maintain the operating capability of the entity,
Share capital represents funds contributed by
pay dividends, and make new investments
shareholders. Share capital has PAR value indicated on
without recourse to external sources of
the face of the share as authorized by SEC.
financing.
Retained earnings is a line item in the equity that
Investing activities are the acquisition and disposal of
represents the accumulated amount of net income or
long-term assets and other investments not included in
loss, errors of prior periods, dividend distribution,
cash equivalents.
changes in accounting policy, and other equity
adjustments other than those arising from contributions  Cash flow from investing activities arise from
from shareholders. the acquisition and disposal of long-term assets
and other investments not included in cash
Reserves are line items in the equity section that include
equivalents.
appropriation reserve, share premium, revaluation
adjustment, and foreign currency translation reserve. Financing activities are activities that result in changes
in size and composition of the contributed equity and
Appropriation Reserve refers to a transfer of an
borrowings of the entity.
amount from the retained earnings.
 Cash flows from financing activities are the
Share premium (in excess of PAR)
result in changes in the size and composition of
PAR value is the minimum issue price of the shares the contributed equity and borrowings of the
appearing on the face of the certificate of stock. entity.

Revaluation adjustment represents the excess of the TREATMENT OF DIVIDENDS, INTEREST, AND
depreciated replacement cost or sound value of the TAX ON INCOME
revaluated PPE over the book value.
Dividends received:
1. Preferential treatment (kina-classify and
dividends received as operating cash flows)
 2. Alternative treatment (DR is classified as - NOTE: Entities are encouraged to report
investing cash flows) cash flows from operating activities using
the direct method.
Dividends paid:
 Indirect Method – under this method, cash flow
1. Preferential treatment (DP as financing cash from operating activities is computed by
flows) adjusting the accrual net income to cash net
2. Alternative treatment (DP as operating cash income.
flows)
Interest received/paid:
1. Preferential treatment (IPD as operating cash
flows)
2. Alternative treatment (IP as financing cash
flow, IR as investing cash flows)
Taxes on income – operating cash flows
NONCASH TRANSACTIONS – investing and
financing activities that do not require the use of cash
and cash equivalents shall be excluded from a cash flow
statement.
The ff. transactions are classified as noncash transactions
and should be disclosed properly:
1. Acquisition of assets by assuming directly
related liabilities
- Equipment (DR)
- Accounts Payable (CR)
2. Acquisition of assets by means of finance
lease
- Equipment
- Long term payable
3. Acquisition of assets by issuance of shares
capital or bonds payable
- Equipment
- Share Capital
4. Acquisition of an entity by means of an entity
issue – investment
5. Conversion of debt to equity (from bonds
payable to ordinary share)
- Bonds payable
- Share Capital
6. Conversion of share capital (from preference
share to ordinary share)
METHODS OF COMPUTING CASH FROM
OPERATING ACTIVITIES

 Direct Method provides information which may

be useful in estimating future cash flows and is
not available under the indirect method.