Accounting Concepts and Principles, IFRS Framework

FUNDAMENTAL CONCEPTS

Several fundamental concepts underlie the accounting process. In recording business transactions,
accountants should consider the following:

1. Entity Concept. The most basic concept in accounting is the entity concept. An accounting entity
is an organization or a section of an organization that stands apart from other organizations and
individuals as a separate economic unit. Simply put, the transactions of different entities should
not be accounted for together. Each entity should be evaluated separately.
2. Periodicity Concept. An entity's life can be meaningfully subdivided into equal time periods for
reporting purposes. It will be aimless to wait for the actual last day of operations to perfectly
measure the entity's net income. This concept allows the users to obtain timely information to
serve as a basis on making decisions about future activities. For the purpose of reporting to
outsiders, one year is the usual accounting period.
3. Stable Monetary Unit Concept. The Philippine peso is a reasonable unit of measure and its
purchasing power is relatively stable. It allows accountants to add and subtract peso amounts as
though each peso has the same purchasing power as any other peso at any time. This is the basis
for ignoring the effects of inflation in the accounting records.
4. Accrual Basis. Accrual accounting depicts the effects of transactions and other events and
circumstances on a reporting entity's economic resources and claims in the periods in which those
effects occur, even if the resulting cash receipts and payments occur in a different period.

NEED FOR GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

In a sole proprietorship, adherence to proper accounting rules is important even though the
owner is usually deeply involved in the firm's activities and is the person primarily interested in its financial
affairs. However, creditors, suppliers, and others must also be able to rely on the financial statements
prepared for a' sole proprietorship. When the

business is a partnership or a corporation, it is even more important that operations be properly

accounted for because owners are unlikely to be intimately involved in the activities of the firm. Generally
accepted accounting principles make financial statement meaningful and useful, regardless of the type of
business organization.

The various needs for reliable financial information can be satisfied only if there are rules,
procedures, and principles of accounting that are generally accepted and used. If each entity made up its
own rules, there could be no basis for comparing the earnings and financial position of different firms.
Even the records and reports of a particular entity could not be compared for different periods unless
accounting principles were applied consistently. In addition, users of financial statements would probably
be misinformed and misled.
DEVELOPMENT OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Many of today's accounting principles were developed over a period of years in response to the
changing needs for business reports. The process has worked very much like this: A particular procedure
is devised by an accountant as a solution to a specific problem. Then, other accountants find the procedure
suitable for their problems and start to use it. Eventually the procedure may become widely used and may
be recognized by professional accountants, accounting writers, and organizations that are responsible for
developing generally accepted accounting principles. Other accounting principles have resulted from a
decision by authoritative, rule-making bodies such as ASC/IASC and FRSC/IASB (see Appendix) to select
one of several alternative methods being used in practice. In other cases, rule-making bodies have
developed standards on the basis of logic or deductive reasoning because no clearly defined practices
were being used to account for certain types of transaction or events.

Businesses and the environment in which they operate are constantly changing. The economy,
technology, and laws change. Therefore, financial information and the methods of presenting that
information must change to meet the needs of the people who use the information. Generally accepted
accounting principles are changed and refined as accountants respond to the changing environment.

CRITERIA FOR GENERAL ACCEPTANCE OF AN ACCOUNTING PRINCIPLE

• The general acceptance of an accounting principle usually depends on how well it meets three
criteria: relevance, objectivity and feasibility.
• A principle has relevance to the extent that it results in information that is meaningful and useful
to those who need to know something about a certain organization.
• A principle has objectivity to the extent that the resulting information is not influenced by the
personal bias or judgment of those who furnish it. Objectivity connotes reliability and
trustworthiness. It also connotes verifiability, which means that there is some way of finding out
whether the information is correct.
• A principle has feasibility to the extent that it can be implemented without undue complexity or
cost.
• These criteria often conflict with one another. In some cases, the most relevant solution may be
the least objective and the least feasible.

BASIC PRINCIPLES

Accounting practices follow certain guidelines. The set of guidelines and procedures that
constitute acceptable accounting practice at a given time is GAAP, which stands for generally accepted
accounting principles. In order to generate information that is useful to the users of financial statements,
accountants rely upon the following principles:

• Objectivity Principle. Accounting records and statements are based on the most reliable data
available so that they will be as accurate and as useful as possible. Reliable data are verifiable
when they can be confirmed by independent observers. Ideally, accounting records are based on
 information that flows from activities documented by objective evidence. Without this principle,
accounting records would be based on whims and opinions and is therefore subject to disputes.
• Historical Cost. This principle states that acquired assets should be recorded at their actual cost
and not at what management thinks they are worth as at reporting date.
• Revenue Recognition Principle. Revenue is to be recognized in the accounting period when goods
are delivered or services are rendered or performed.
• Expense Recognition Principle. Expenses should be recognized in the accounting period in which
goods and services are used up to produce revenue and not when the entity pays for those goods
and services.
• Adequate Disclosure. Requires that all relevant information that would affect the user's
understanding and assessment of the accounting entity be disclosed in the financial statements.
• Materiality. Financial reporting is only concerned with information that is significant enough to
affect evaluations and decisions. Materiality depends on the size and nature of the item judged
in the particular circumstances of its omission. In deciding whether an item or an aggregate of
items is material, the nature and size of the item are evaluated together. Depending on the
circumstances, either the nature or the size of the item could be the determining factor.
• Consistency Principle. The firms should use the same accounting method from period to period
to achieve comparability over time within a single enterprise. However, changes are permitted if
justifiable and disclosed in the financial statements.

CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING (IFRS FRAMEWORK)

Purpose and Scope

The New IFRS Framework describes the basic concepts that underlie the preparation and
presentation of financial statements for external users. The framework deals with the objective of
financial statements; the qualitative characteristics that determine the usefulness of information in
financial statements; the reporting entity; the definition, recognition and measurement of the elements
from which financial statements are constructed; and concepts of capital and capital maintenance.

Objective of General-Purpose Financial Reporting

The objective of general-purpose financial reporting is to provide financial information about the
reporting entity that is useful to present and potential investors, lenders and other creditors, who use
that information to make decisions about buying, selling or holding equity or debt instruments and
providing or settling loans or other forms of credit.

The primary users need information about the resources and claims against the resources of the
entity not only to assess an entity's prospects for future net cash inflows but also how effectively and
efficiently management has discharged their responsibilities to use the entity's existing resources (i.e.,
stewardship).

The classical notion of stewardship was focused on how the money and the other assets entrusted
to the steward (i.e. in previous times, a steward is the one employed by a large household or estate to
manage domestic concerns such as supervision of servants, collection of rents and keeping of accounts)
by the owner were used, and how much money and other assets were present at the end of the reporting
period. Financial statements also show the results of the stewardship of management, that is the
accountability of management for the resources entrusted to it by the owner(s).

The framework notes that general-purpose financial reports cannot provide all the information
that users may need to make economic decisions. They will need to consider pertinent information from
other sources, for example, general economic conditions and expectations, political events and political
climate, and industry and company outlooks. The management of a reporting entity is also interested in
financial information about the entity. However, management need not rely on general-purpose financial
reports because it is able to obtain the financial information it needs internally.

QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION

The qualitative characteristics of useful financial reporting identify the types of information are
likely to be most useful to users in making decisions about the reporting entity on the basis of. information
in its financial report. The qualitative characteristics apply equally to financial information in general-
purpose financial reports as well as to financial information provided in other ways. The Framework
identifies two fundamental qualitative characteristics and four enhancing qualitative characteristics as
follows:

Financial information is useful when it is relevant and represents faithfully what it purports to
represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and
understandable.
Fundamental Qualitative Characteristics

Relevance and faithful representation are the fundamental qualitative characteristics of useful
financial information. Information must be both relevant and faithfully represented if it is to be useful.
Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a
relevant phenomenon helps users make good decisions.

Relevance

Relevant financial information is "capable of making a difference in the decisions made by users."
Financial information is capable of making a difference in decisions if it has predictive value, confirmatory
value, or both. The predictive value and confirmatory value of financial information are interrelated.

Financial information has a confirmatory value when "it provides feedback about (confirms or
changes) previous evaluations."

Financial information has a predictive value when "it can be used as an input to processes
employed by users to predict future outcomes." To have predictive value, information need not be in the
form of an explicit forecast.

Therefore, for information to be relevant, it should assist in either the confirmation of past
predictions or in the making of new predictions.

Materiality is also part of relevance. Information is material "if omitting it or misstating it could
influence decisions that users make on the basis of financial information about a specific reporting entity."

Faithful Representation

1. General-purpose financial reports represent economic phenomena in words and numbers. To be

useful, financial information must not only be relevant, it must also represent faithfully the
phenomena it purports to represent. This fundamental characteristic seeks to maximize the
underlying characteristics of completeness, neutrality and freedom from error.
2. Completeness. A complete depiction includes "all information necessary for a user to understand
the phenomenon being depicted, including all necessary descriptions and explanations." For
example, a complete depiction of a group of assets would include, at a minimum, a description of
the nature of the assets in the group, a numerical depiction of all the assets in the group, and a
description of what the numerical depiction represents (for example, original cost, adjusted cost
or fair value).
3. Neutrality. Free from bias or "unbiased in the selection or presentation of financial information."
A neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise
manipulated to increase the probability that financial information will be received favorably or
unfavorably by users. Financial statements are not neutral if, by the selection or presentation of
information, they influence the making of a decision or judgment to achieve a predetermined
result or outcome.
4. Freedom from Error. Simply put, "there are no errors or omissions for the reported information."
Or, "there are no errors or omissions in the description of the transaction and other events, and
no errors have been made in selecting and applying an appropriate process to produce the
 reported information." In this context, free from error does not mean perfectly accurate in all
respects.

Enhancing Qualitative Characteristics

Comparability, verifiability, timeliness and understandability are qualitative characteristics that

enhance the usefulness of information that is relevant and faithfully represented.

Comparability

Comparability "enables users to identify and understand similarities in, and differences among,
items." Information about a reporting entity is more useful if it can be compared with similar information
about other entities and with similar information about the same entity for another period or another
date. Unlike the other qualitative characteristics, comparability does not relate to a single item. A
comparison requires at least two items.

Consistency, although related to comparability, is not the same. Consistency refers to the use of
the same methods for the same items, either from period to period within a reporting entity or in a single
period across entities. Comparability is the goal; consistency helps to achieve that goal. Comparability is
not uniformity. For information to be comparable, like things must look alike and different things must
look different.

Verifiability

Verifiability helps "assure users that information represents faithfully the economic phenomena
it purports to represent." Verifiability means that different knowledgeable and independent observers
could reach consensus, although not necessarily complete agreement, that a particular depiction is a
faithful representation."

Timeliness

Timeliness means that "information is available to decision-makers in time to be capable of

influencing their decisions." Generally, the older the information is, the less useful it is.

Understandability

"Classifying, characterizing and presenting information clearly and concisely" makes it

understandable. While some phenomena are inherently complex and cannot be made easy to
understand, to exclude such information would make financial reports incomplete and potentially
misleading. Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyze the information with diligence.

Applying the Enhancing Qualitative Characteristics

 Enhancing qualitative characteristics should be maximized to the extent necessary. However,
enhancing qualitative characteristics (either individually or collectively) cannot render information useful
if that information is irrelevant or not represented faithfully.

Cost Constraint on Useful Financial Reporting

Cost is a pervasive constraint on the information that can be provided by general-purpose

financial reporting. Reporting such information imposes costs and those costs should be justified by the
benefits of reporting that information. This constraint looks at both the importance and relative size of an
amount. The cost-benefit constraint prescribes that only information with benefits of disclosure greater
than the costs of providing it need be disclosed.

UNDERLYING ASSUMPTION

Going Concern

The financial statements are normally prepared on the assumption that an enterprise is a going
concern and "will continue in operation for the foreseeable future." Hence, it is assumed that the
enterprise has "neither the intention nor the necessity of liquidation or curtailing materially the scale of
its operations."

This assumption underlies the depreciation of assets over their useful lives. If an entity expects to
liquidate in the near future, its assets are valued at their worth at liquidation rather than original cost.

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 the measurement of financial position
in the balance sheet are assets, liabilities and equity.

The elements directly related to the measurement of performance in the income statement are
income and expenses. The statement of changes in financial position usually reflects income statement
elements and changes in balance sheet elements. Detailed discussions of the elements of financial
statements can be found in Chapter 4, The Accounting Equation and the Double-Entry System.
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 criteria for recognition. An item that meets the
definition of an element should be recognized if:

• it is probable that any future economic benefit associated with the item will flow to or
from the-enterprise; and
• the item has a cost or value that can be measured with reliability.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS

Measurement is the process of determining the monetary amounts at which the elements of the
financial statements are to be recognized and carried in the balance sheet and income statement. This
involves the selection of a particular basis of measurement. A number of these are used to different
degrees and in varying combinations in financial statements. They include the following:

1. Historical Cost. Assets are recorded at the amount of cash or cash equivalents paid or the fair
value of the consideration given to acquire them at the time of their acquisition. Liabilities are
recorded at the amount of proceeds received in exchange for the obligation, or in some
circumstances (for example, income taxes), at the amounts of cash or cash equivalents expected
to be paid to satisfy the liability in the normal course of business.
2. Current Cost. Assets are carried at the amount of cash or cash equivalents that would have to be
paid if the same or an equivalent asset was acquired currently. Liabilities are carried at the
undiscounted amount of cash or cash equivalents that would be required to settle the obligation
currently.
3. Realizable (Settlement) Value
a. Realizable Value. Assets are carried at the amount of cash or cash equivalents that could
currently be obtained by selling an asset in an orderly disposal.
b. Settlement Value. Liabilities are carried at the undiscounted amounts of cash or cash
equivalents expected to be paid to satisfy the liabilities in the normal course of business.
4. Present Value. Assets are carried at the present discounted value of the future net cash inflows
that the item is expected to generate in the normal course of business. Liabilities are carried at
the present discounted value of the future net cash outflows that are expected to be required to
settle the liabilities in the normal course of business.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

A financial concept of capital is adopted by most enterprises in preparing the financial statements.
Under a financial concept of capital, such as invested money or invested purchasing power, capital is
synonymous with the net assets or equity of the enterprise. A profit is earned only if the financial (or
money) amount of the net assets at the end of the period exceeds the financial (or money) amount of net
assets at the beginning of the period, after excluding any distributions to and contributions from owners
during the period.
 Under a physical concept of capital, such as operating capability, capital is regarded as the
productive capacity of the enterprise based on, for example, units of output per day. A profit is earned
only if the physical productive capacity (or operating capability) of the enterprise (or the resources or
funds needed 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.

The principal difference between the two concepts of capital maintenance is the treatment of the
effects of changes in the prices of assets and liabilities of the enterprise. At the present time, no particular
model is prescribed.

ACCOUNTING STANDARDS IN THE PHILIPPINES

Accounting standards are authoritative statements of how particular types of transaction and
other events should be reflected in financial statements. Accordingly, compliance with accounting
standards will normally be necessary for the fair presentation of financial statements.

Accounting Standards Council (ASC)

On Nov. 18, 1981, the Philippine Institute of Certified Public Accountants (PICPA) created the
Accounting Standards Council (ASC) to establish and improve accounting standards that will be generally
accepted in the Philippines.

The creation of the Council received the support of the following: the Securities and Exchange
Commission (SEC) and the Central Bank of the Philippines (CB)—regulatory agencies where the financial
statements are filed; the Professional Regulation Commission (PRC) through the Board of Accountancy—
which supervises CPAs and auditors; and the Financial Executives Institute of the Philippines (FINEX)—
which is the largest organization of financial executives who are responsible for the preparation of the
financial statements. The ASC was composed of eight (8) members—four from PICPA including the
designated Chairman; and one each from SEC, CB, PRC and FINEX.

The standards would generally be based on the following: existing practices in the Philippines;
research or studies by the Council; locally or internationally available literature on the topic or subject;
and statements, recommendations, studies or standards issued by other standard-setting bodies such as
the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board
(FASB).

The statements and interpretations issued by the Council represent generally accepted
accounting principles in the Philippines. Accounting principles become generally accepted if they have
substantial authoritative support from the relevant parties interested in the financial statements—the
preparers and users, auditors and regulatory agencies.
Financial Reporting Standards Council (FRSC)

Per Section 9(A) of the Rules and Regulations Implementing Republic Act 9298 otherwise known
as the Philippine Accountancy Act of 2004, the Financial Reporting Standards Council (FRSC) shall be the
new accounting standard setting body thus, replacing the Accounting Standards Council (ASC).

The FRSC shall be composed of fifteen (15) members with a Chairman, who had been or presently
a senior accounting practitioner in any of the scope of accounting practice and fourteen (14)
representatives from the following: one each from the BOA, SEC, BSP, BIR, COA and a major organization
composed of preparers and users of financial statements; and two representatives each from the
accredited national professional organization of CPAs in public practice, commerce and industry,
education/academe and government.

International Accounting Standards Committee (IASC) and International Accounting Standards Board
(IASB)

The International Accounting Standards Board (IASB) is an independent private sector body. Its
objective is to achieve convergence in the accounting principles that are used by businesses and other
organizations for financial reporting around the world.

Effective April 1, 2001, the International Accounting Standards Board (IASB) assumed accounting
standard setting responsibilities from its predecessor body, the International Accounting Standards
Committee (IASC). The International Accounting Standards Committee was formed in 1973 through an
agreement made by professional accountancy bodies from Australia, Canada, France, Germany, Japan,
Mexico, the Netherlands, the United Kingdom and Ireland, and the United States of America.

Statements of International Accounting Standards issued by the Board of the International

Accounting Standards Committee (1973-2001) are designated "International Accounting Standards" (IAS).
The International Accounting Standards Board announced in April 2001 that its accounting standards
would be designated "International Financial Reporting Standards" (IFRS).

Philippine ASC Moves to IAS/IFRS

In developing accounting standards that will be generally accepted in the Philippines, the
Accounting Standards Council (ASC) considered standards issued by other standard-setting bodies such as
the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards
Committee (now the IASB). In the past years, the ASC based most of the standards it issued on U.S.
accounting standards. Starting in 1996, however, the ASC issued accounting standards that were based
on international accounting standards. In 1997, the ASC made a decision to move totally to International
Accounting Standards (IAS) and eventually to International Financial Reporting Standards (IFRS).

Accounting standards issued by the ASC were renamed to correspond better with the issuances
of the IASC and IASB. Philippine Accounting Standards (PASs) correspond to the adopted International
Accounting Standards (IASs). Philippine Financial Reporting Standards (PFRSs) correspond to the adopted
International Financial Reporting Standards (IFRSs). SFASs and SFASs/lASs not superseded by revised IASs
and new IFRSs will be re-issued as PASs. Previously, standards issued by the ASC were designated as SFASs.