ESSENCE OF FINANCIAL STATEMENTS

 Financing activities (Roots):

- Owners contribute cash and
receive equity shares in return.
- Creditors loan cash
 Investing activities (Trunk and
branches):
- Once the capital is collected it is
invested in producing assets,
 Operating activities (Fruit):
- The assets are operated to
produce goods

The Net Income of these sales can be

used in three ways:
1. Reinvested in the producing assets
2. Returned to the creditors
3. Returned to the owners as dividends

Financial Statements are designed to measure different aspects Define different aspects of
of the business (the fruit tree): business
 The Statement of Financial Position
- a picture of the tree (fruit, branches, trunk & roots) at a Financing Sources
certain point in time. It includes assets (inventory of goods Equity, debts, & investment
and producing assets) and financing sources of the business. from net income of the business.

 The Statement of Comprehensive Income

- Accounts for all activities involved in the operation of the
business (growing and selling the fruit) over a period of time.
It contains a list of all operating expenses and revenues of
the business.

 The Statement of Changes in Owner’s Equity

- reports the changes in the equity account of the proprietor
of the business while
The Statement of Changes in Retained Earnings
- reports how much of the net income from the operating
activities are retained by the business and how much paid as
dividends.

 The Statement of Cash Flow

- Details all the cash inflows and outflows that occurred over a
period of time associated with the operating (fruit),
investing (trunk and branch) and financing (roots) activities
of the business.
Importance of Financial Statements Provide information about
- Financial statements are important because they contain company’s revenue, expenses,
significant information about a company's financial health.  profitability, underlying debts of
- It helps companies make informed decisions since they the business.
highlight which areas of the company provide the best ROI
(return on investment).
- It provides a snapshot of a corporation's financial health,
giving insight into its performance, operations, and cash
flow.  Shareholders
- Shareholders need them to make informed decisions about Owners of the corporation
their equity investments, especially when it comes time to
vote on corporate matters.
- In order to make better decisions, it is important for them to
analyze their stocks using a variety of measurements, rather
than just a few.
- Some of the metrics, Metrics are measures of quantitative
assessment commonly used for assessing, comparing, and
tracking performance or production. Generally, a group of
metrics will typically be used to build a dashboard that
management or analysts review on a regular basis to
maintain performance assessments, opinions, and business
strategies,  available include profitability
ratios, liquidity ratios (ease with which an asset, or security,
can be converted into ready cash without affecting
its market price), debt ratios, efficiency ratios, and price
ratios.

STEP 7: THE FINANCIAL STATEMENTS

After the preparation of the Worksheet is completed, the
information it provides are now used to create the financial
statements which are the results of routine transactions of the
accounting process. The primary statements comprise of:
a. Statement of Comprehensive Income
b. Statement of Financial Position
c. Statement of Changes in Owner’s Equity
d. Statement of Cash Flows
e. Notes to FS, comprising a summary of significant accounting
policies and other explanatory notes comparative information
prescribed by the standard.
f. Other titles for the statements other than those stated above
which are required to be presented with equal prominence.

These financial reports were used by the stakeholders to assess

the business and to evaluate management’s stewardship of the
entity’s economic resources.
PREPARATION OF FINANCIAL STATEMENTS
- The financial statements are the end product of the
accounting process. Information from the journal and the
ledger are meaningless to most users unless they are
summarized and communicated through the financial
statements. This is the very purpose of the accounting
system and the ultimate guide is the Worksheet.

A. STATEMENT OF COMPREHENSIVE INCOME (in conformity PAS- Philippine Accounting

with PAS and PFRS) Standard
- It is usually the first statement prepared by the bookkeeper PFRS- Philippine Financial
or accountant. Reporting Standard
- It shows the results of business operations for a given
period and evaluates the success of the business through its
operating performance.
- It communicates to the interested users the profitability of
the business.
- It covers a certain accounting period, monthly or annual and
it presents revenues earned, expenses incurred, gains and
losses from other activities of the business and the NET
INCOME or NET LOSS recognized during the period.

Two major parts:

1. Heading – name of the business; name of the report and date
of the statement written as “For the year ended”, “For the
month ended” or “For quarter ended” which indicates the
coverage period of the statement.
2. Body – it contains the two (2) accounting elements: INCOME
and EXPENSES.

SOME GUIDELINES TO FOLLOW:

- Concentrate only on the section of statement of
comprehensive income in the worksheet.
- The data on the credit side represents Revenues.
- The data on the debit side represents costs and expenses.
- The amount of net income or net loss should equal the
amount in the worksheet.
 B. STATEMENT OF FINANCIAL POSITION
- A structured financial statement that shows the resources Resources – asset
employed by the business, and the sources from which Sources – liability & owner’s
these resources were acquired. equity
- There are two claims against the assets of the business-
claim of the creditors (technically known as Liabilities) and
claim of the owners (Capital).
- The SFP indicates Liquidity and Solvency status of the
business.
Liquidity-the ability of the business to pay its currently
maturing obligations.
Solvency –the capacity of the business to settle its non-
current liabilities and still remain stable.
- It presents three accounting elements-ASSETS, LIABILITIES
and OWNER’S EQUITY and is prepared at a given date in
conformity with the requirements of PAS and PFRS.
- The date “As of” implies that the information presented in
the statement is true and correct only as of that date.
- It follows the line item presentation and the composition of
the line item are properly disclosed in the notes to financial
statements.
- There two forms to present the SFP are: Account form and
Report form.

SOME GUIDELINES TO BE FOLLOWED:

- The title of the statement is written at the center.
- The Asset and Liability section are properly divided into two
parts: CURRENT portion and the NON-CURRENT portion.
- The account titles are properly indented and in cases where
there are contra-accounts like allowance for Doubtful
accounts and Accumulated depreciation, the related main
account is short extended and only the net amount or net
realizable value, is extended to the next money column.
- The final amount which is the Total Assets should be aligned
with the Total Liabilities and Owner’s Equity

The Philippine Financial Reporting Standards (PFRS) requires

that the presentation of financial statement follows the aggregation
principle and line item concept.

As a minimum requirement, the Statement of Financial Position shall

include the following:
 For the Current Asset section
a. Cash and Cash equivalent
b. Financial Assets
c. Trade and Other Trade Receivables
d. Inventories
e. Prepaid Expenses
  For the Non-Current Asset Section
a. Property, Plant and Equipment
b. Long-term Investments
c. Intangibles
d. Other Non-Current Assets
 For Current Liabilities
a. Trade and Other Payables
b. Short-term bank borrowings
c. Current portion of long-term obligations
d. Current provisions
e. Current tax Liabilities
 For the Long-term Liabilities
a. Bank Loan Payable
b. Mortgage Payable
c. Deferred Tax Liability

The Statement of Financial Position

The balance sheet provides a picture of the company’s financial
situation at one point in time. It is based on the fundamental
accounting equation:

Assets = Liabilities + Equity

The capitalist/entrepreneur/proprietor own the company. Its net
worth is (Assets – Liabilities) = Equity.

This is called book value of the company which differs from market
value.

Assets:
Items and right acquired through objectively measurable transactions
that can be used in the future to generate economic benefits.

Liabilities:
Primarily a firm’s debt and payables. The total amount of liabilities is
the portion of assets that a firm has borrowed and must repay.

Owner’s Equity:
Consists of contributed capital and temporary withdrawals.

C. THE STATEMENT OF CHANGES IN OWNER’S EQUITY

- It presents the different elements that affect the equity of
the owner or owners during a particular period.
- The presentation starts with the beginning capital of the
owner or owners and adjusted by the following items:
1. Net Income or loss during the period
2. Additional investments
3.Temporary withdrawal of capital
 - The net income and additional investments are added to the
beginning capital while the Net Loss and temporary
withdrawals are deducted.

D. STATEMENT OF CASH FLOW

The statement of cash flows provides information about
the cash receipts(sources) and cash payments (uses) of an
entity during a period.
- It is a formal statement that classifies cash receipts
(inflows) and cash payments (outflows) into operating,
investing and financing activities.
- This statement shows the net increase or decrease in cash
during the period and the cash balance at the end of the
period; it also helps project the future net cash flows of the
entity.
- The cash flow statement explains the change during the
period in cash and cash equivalents.
- Cash includes currency on hand and demand deposits
while Cash equivalents are short-term, highly liquid
investments that are readily convertible to cash.
- The amount of ending Cash balance reflected in the
Statement of Cash Flows should be equal to the Cash
balance in the Statement of Financial Position

Importance of Cash Flow Statement

 Cash Flow Statement is one of the most important but
often overlooked components of a firm’s financial
statements.
 Without proper cash management, regardless of how
fast a firm’s sales or reported profits on the income
statement are growing, a firm cannot survive without
carefully ensuring that it takes in more cash than it sends
out the door.
 The cash flow statement bridges the gap between the
income statement and the balance sheet by showing
how much cash is generated or spent on operating,
investing, and financing activities for a specific period.

Components of A Cash Flow Statement:

BUSINESS ACTIVITIES
The economic activities of the business are classified into:
Operating, Investing and Financing activities.

A. Operating Activities
The statement provides information about the cash
generated from a company’s daily operating activities.
- Operating activities are those which produce either
revenue or are the direct cost of producing a product or
service. Ex. CASH INFLOWS for the business such as
customer collections from sales of their primary
 products or services, receipts of interest and dividends,
and other operating cash receipts.
- Operating activities which create CASH OUTFLOWS
include payments to suppliers, payments to employees,
interest payments, payment of income taxes and other
operating cash payments.

ITEMS ON OPERATING ACTIVITIES AND THEIR EFFECTS ON CASH

FLOWS ARE:
INCREASE IN CASH:
Cash Receipts/ Inflows from:
• Sale of goods and services
• Sale of trading securities
• Interest Income
• Dividend income
DECREASE IN CASH:
Cash Payments/ Outflows for:
• Purchase of goods or services
• Operating expenses
• Taxes
• Short-term interest expense

B. Investing Activities
The activities from investing arise from business
transactions involving acquisition and disposal of assets other
than inventory, which are needed in the operation of the
business.
- The primary purpose of investing activities is to acquire
Assets in order to assist and facilitate business
operations.
- Investing activities include purchases of physical assets,
investments in securities, or the sale of securities or
assets.

Negative cash flow is often indicative of a company's poor

performance. 
However, negative cash flow from investing activities
might be due to significant amounts of cash being invested in
the long-term health of the company, such as research and
development.

ITEMS ON INVESTING ACTIVITIES AND THEIR EFFECTS ON CASH

FLOWS ARE:
INCREASE IN CASH:
Cash Receipts/ Inflows from:
• Sale of fixed assets
• Sale of non-trading/ investment securities
• Sale of a business segment
• Collection of loans and insurance proceeds
DECREASE IN CASH:
Cash Payments/ Outflows for:
• Purchase of plant assets
• Purchase of investments such as stocks or securities
• Lending money/ or making loans to others

C. Financing Activities
The financing activities in the cash flow statement focuses
on how a firm raises Capital and pays it back to investors
through Capital Markets. This include transactions with
creditors or investors used to fund either company operations
or expansions.

• Capital Markets – are venues where savings and

Markets for long-term assets
investments are channeled between the
supplier of funds who have capital and
those whore in need of capital (users of
funds).

- The cash flow from financing activities are funds that

the business took in or paid to finance its activities.
- These activities involve the flow of cash and cash
equivalents between the company and its sources of
finance-i.e. the investors and creditors for non-trading
liabilities such as long-term loans, bonds payable, etc.
- Financing activities include payment of cash dividends,
adding or changing loans, or issuing and selling more
stocks.

• Stocks – ownership share in a particular company

evidenced by stock certificate.

ITEMS ON FINANCING ACTIVITIES AND THEIR EFFECTS ON CASH

FLOWS ARE:
Bond
INCREASE IN CASH: A long-term obligation evidence
Cash Receipts/ Inflows from: by certificate of indebtedness
• Owner’s investments
• Borrowings/loan from
• Issuing of bonds
• Sale of treasury of stock
• Cash from new stock issued
DECREASE IN CASH:
Cash Payments/ Outflows for:
• Owner’s drawings
• Payment of borrowings/ settlement of debt
• Payment of cash dividends
• Purchase of treasury stock
• Repurchase of existing stock
 • Redemption of bonds

The first step in preparing the cash flow statement is to

determine the net increase in cash and cash equivalents for the
period. This amount will be a control figure and the cash flow
statement will reconcile the inflows and outflows (sources and uses)

to this figure. There are two (2) methods used to prepare the
Statement of Cash Flows:

RELATIONSHIP OF FINANCIAL STATEMENTS

 ACCOUNTING ERRORS
Errors are hardly avoided in
NATURE OF ACCOUNTING ERRORS recording business transaction
- Errors in the recording process, whether intentionally made to
commit fraud or irregularities or honestly committed mistakes, To avoid suspicion
must be corrected.
- The accounting errors committed in recording economic
transactions will certainly result in the inaccuracy of the
accounting records.
- Accounting errors may have been detected after journalizing
several transactions in the books of accounts or after the trial
balance has been prepared.
- An error is rectified in the books of accounts by creating another
entry called correcting entry.
Correcting entry is a journal entry designed to remove an erroneous
entry made on the journal and the ledger.
- The commission of errors in recording violates the principle of
Reliability.
- It is the responsibility of the accountant to effect corrections
upon discovery of an accounting error.
- When errors are detected, it is often immediately fixed and if
there is no immediate resolution, an investigation into the error
is conducted.

Accounting Errors
- unintentional mistakes in bookkeeping of transactions and the
most common accounting errors are either clerical mistakes or
errors of accounting principle.
 Accounting errors are different from accounting fraud because in
fraud an intentional mistake is made to misrepresent financial
information or to conceal misappropriation of assets.
 Where a trial balance is imbalanced by accounting errors, the
difference between the debit and credit totals of the trial
balance is temporarily kept in suspense account until the errors
are corrected.

CLASSIFICATION OF ACCOUNTING ERRORS

These are common errors encountered in recording business
transactions which might also have overlapping characteristics.

1. Transposition error – a type of error where the position of figures is

interchanged and as a result, this may either overstate or understate
the amount of the related transaction.
Ex: On September 3, 2016, Ms. MA, the bookkeeper of King
Enterprises, recorded services rendered on account for P254,000
instead of P245,000 as follows:

Date Erroneous Entry PR Debit Credit

Sept. 3 Accounts Receivable P 254,000

Service Revenue P254,000
The error overstates both Accounts Receivable and Service
Revenue by P9,000 and IF NOT corrected, the Asset portion of
Statement of Financial Position and the Net Income of Statement of
Comprehensive Income will be both overstated and the Owner’s
Equity section will also be overstated by 9,000.
Date Correcting entry PR Debit Credit

Sept. Service Revenue P 9,000

3 Accounts Receivable P9,000
To correct overstatement of
service revenue on account.

Note: To prove the accuracy of the correcting entry, the use of T-

Account would be helpful by checking whether the overstatement on
both accounts was reduced.
 The accounting error may be discovered at any point of the
stages stated above and their corresponding corrections would
be dependent on the stage when such error was discovered.
 If the error is discovered immediately at the time of journal entry
and no succeeding journal entry is made, then the error could be
corrected by simply drawing a straight line over the erroneous
entry and replacing it with the correct entry and the signature of
the person making the correction.

2. Transplacement Error – a term used when there is inaccuracy in the

placement of decimal places as when P21,750.00 is copied as
P2,175.00. IF NOT corrected the error will either understate or
overstate the transactions recorded.
EX: The bookkeeper of Hans Auto Shop recorded a P2,000 collection
of accounts receivable as P20,000 on April 5.
3. Error of Account titles - error committed when an inappropriate
account title is recorded in lieu of the appropriate account title that
describes the economic transactions.
EX: On Nov. 5, ABC Car Rental rendered services on account for
P300,000 but the bookkeeper recorded it as:

4. Error of omission – the error is committed when the economic

transaction is not recorded. The correcting entry is to record the
transaction such as:
EX: Hunter Training School rendered services for a group of tourists
and received P100,000.
12/31 Cash P100,000
Service Revenue P100,000
To record unrecorded cash
received from Customers.

5. Errors of Principle - Errors that involve violation of accounting

principles, misinterpretation of facts, unintentional unrealistic
estimates or incorrect method of calculation.
These errors are usually caused due to insufficient accounting
knowledge.
Ex: Recognizing expense in wrong accounting period, recognizing
unearned revenue as income instead of a liability, inconsistent
application of accounting principles, etc.

6. Clerical Errors - It is in human nature to make mistakes.

Ex: An accountant may inadvertently enter an incorrect figure in
accounts. Such errors are known as clerical errors.
Clerical errors may be minimized with experience and it has the
following sub-types:
• Arithmetic: Errors in calculations other than incorrect method of
calculation.
Ex: Calculations such as 3+2×6 may be incorrectly done by performing
addition before multiplication, thus arriving at 30 as the answer.
However, the correct answer is 15.
(PEMDAS)

7. Misplacement error: Entering a transaction in wrong account.

Ex: Recording amount of receivable from Customer A to Customer B’s
account.

SUMMARY OF CORRECTING ENTRIES:

The correcting entry as to the stage when the error was discovered
could be classified as follows:
1. Nominal Account still open- correcting entry for error
discovered when the nominal accounts are still open.
To illustrate: Assume that ACT Tutorial Center purchased an
equipment worth P50,000 on account and this recorded in the
books as:

2. Nominal accounts temporarily closed – a correcting entry for

error discovered when nominal accounts are already closed to
the Income Summary account but not yet closed to Owner’s
Capital account.
Office Equipment P50,000
Income Summary P50,000

3. Prior Period Corrections – a correcting entry for errors

discovered when the Income Summary account is already
closed to the owner’s capital account. This entry is called prior
period correcting entry or prior period adjustments.
12/31 Office Equipment P50,000 P50,000
Owner’s Capital Account
To correct prior period
erroneous entry on purchase of
equipment