ACCTG232: INTERMEDIATE ACCOUNTING 3

SUMMARY NOTES AND EXERCISES

CHAPTER 1

FINANCIAL STATEMENTS

Financial statements are the means by which the information

accumulated and processed in financial accounting is periodically
communicated to the users

General purpose financial statements – those statements intended to

meet the needs of users who are not in a position to require an entity to
prepare reports tailored to their particular information needs.

Components of financial statements

A complete set of financial statements comprises the following
components:
1. Statement of financial position
2. Income statement
3. Statement of comprehensive income
4. Statement of changes in equity
5. Statement of cash flows
6. Notes, comprising a summary of significant accounting policies and
other explanatory information

Objective of financial statements

To provide information about the financial position, financial
performance and cash flows of an entity that is useful to a wide range of
users in making economic decisions.

Financial statements should provide information about the following:

A. Assets
B. Liabilities
C. Equity
D. Income and expenses, including gains and losses
E. Contributions by and distribution to owners in their capacity as
owners
F. Cash flows
Such information, along with other information in the notes, would assist
users of financial statements in predicting the entity’s cash flows and in
particular their timing and certainty.

Target users of financial reporting

Directed primarily to the existing and potential investors, lenders and other
creditors which compose the primary user group.

Specific objectives of financial reporting

The Conceptual Framework for Financial Reporting states the following
objectives of financial reporting:
a. To provide information useful in making investing and credit decisions
about providing resources to the entity
b. To provide information useful in assessing the cash flow prospects of
the entity
c. To provide information about entity resource, claims and changes in
resources and claims

Limitations of financial reporting

A. General purpose financial reports do not and cannot provide all of the
information that existing and potential investors, lenders and other
creditors need
B. General purpose financial reports are not designed to show the value
of reporting entity but these reports provide information to help the
primary users estimate the value of the entity
C. General purpose financial reports are intended to provide common
information to users and cannot accommodate every specific request
for information.
D. To a large extent, financial reports are based on estimate and
judgment rather than exact depiction

Responsibility for financial statements

The management of an entity has the primary responsibility for the
preparation and presentation of financial statements.

General features of financial statements

1. Fair presentation and compliance with PFRS
2. Going concern
3. Accrual basis
 4. Materiality and aggregation
5. Offsetting
6. Frequency of reporting
7. Comparative information
8. Consistency of presentation

Fair presentation
Financial statements shall present fairly the financial position, financial
performance and cash flows of an entity.
This is achieved if the financial statements are prepared in accordance with
the Philippine Financial Reporting Standards which represent the GAAP in
the Philippines

An entity whose financial statements comply with PFRS shall make an

explicit and unreserved statement of such compliance in the notes.

Fair presentation is defined as faithful representation of the effects of

transactions and other events in accordance with the definitions and
recognition criteria for assets, liabilities, income and expenses laid down in
the Conceptual Framework.

An entity is permitted to depart from a standard:

a. In extremely rare circumstances
b. When management concludes that compliance with the standard
would be misleading
c. When the departure from the standard is necessary to achieve fair
presentation
d. When the regulatory Conceptual Framework requires or otherwise
does not prohibit such a departure

In such circumstances, it is incumbent upon the entity to disclose the

following:
1. The management has concluded that the financial statements
present fairly the financial position, financial performance and cash
flows of the entity
2. That the entity has complied with applicable standards except that it
has departed from a particular requirement to achieve a fair
presentation
3. The title of the standard from which the entity has departed, the
nature of the departure, including the treatment that the standard
 would require, the reason why that treatment would be so misleading
and the treatment adopted.
4. For each period presented, the financial impact of the departure on
each item in the financial statements that would have been reported
in complying with the requirement.

Going concern
This means that the accounting entity is viewed as continuing operation
indefinitely in the absence of evidence in the contrary

Financial statements are prepared normally on the assumption that the

entity shall continue in operation for the foreseeable future.

Thus, assets are normally recoded at original acquisition cost. As a rule,

market values are ignored.

Accrual Basis
Assets are recognized when receivable rather than physically received, and
liabilities are recognized 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.

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.

When is an item material?

An item is material if knowledge of it would affect the decision of the
informed users of the financial statements.

Materiality of an item depends on relative size rather than absolute sixe.

Factors of materiality
1. Relative size of the item in relation to the total of the group to which
the item belongs.
 2. Nature of the item – An item maybe inherently material because by its
very nature it affects economic decision.

Offsetting
Assets and liabilities, and income and expenses, when material shall not be
offset against each other.

Offsetting may be done when it is required or permitted by another PFRS.

Frequency of reporting
An entity shall present a complete set of financial statements at least
annually.

When an entity changes the end of the reporting period and presents
financial statements for a period longer or shorter than one year, the entity
shall disclose:
a. The period covered by the financial statements
b. The reason for using a longer or shorter period
c. The fact that amounts presented in the financial statements are not
entirely comparable

Comparable information
Except when permitted or required otherwise by PFRS, an entity shall
disclose comparative information in respect of the previous period for all
amounts reported in the current period’s financial statement.

Third statement of financial position

A third statement of financial position is required when an entity:
a. Applies an accounting policy retrospectively
b. Makes retrospective restatement of items in the financial statements
c. Reclassifies items in the financial statements

Under these circumstances, an entity shall present three statements of

financial position as at:
1. The end of the current period
2. The end of the previous period
3. The beginning of the earliest comparative period

Consistency of presentation
Accounting methods and practices shall be applied on a uniform basis from
period to period.

A change in the presentation and classification of items in the financial

statement is allowed:
a. When it is required by another PFRS
b. When a significant change in the nature of the operations of the entity
will demonstrate a more appropriate revised presentation and
classification.

Identification of financial statements

Financial statements shall be clearly identified and distinguished from other
information in the same published document.

Each component of the financial statements shall be clearly identified.

In addition, the following information shall be prominently displayed:

1. The name of the reporting entity
2. Whether the financial statements cover the individual entity or group
of entities
3. The end of the reporting period or the period covered by the financial
statements or notes
4. The presentation currency
5. The level of rounding used in the amounts in the financial statements.

Financial statements are often made more understandable by presenting

information in thousands or millions of units of the presentation currency.

EXERCISES

Multiple Questions
1. A complete set of financial statements includes all of the following
components, except
a. Statement of financial position
b. Statement of changes in equity
c. Notes to financial statements
d. Environmental reports and value added statements

2. What is the objective of financial statements?

 a. To provide information about the financial position, financial
performance, and changes in financial position useful to a wide
range of users.
b. To prepare a statement of financial position and statement of
comprehensive income
c. To present relevant, reliable, comparable and understandable
information
d. To prepare financial statements in accordance with all applicable
standards

3. The primary responsibility for the preparation of the financial

statements is reposed in
a. Management of the entity
b. Internal auditor
c. External auditor
d. Controller

4. The major financial statements include all, except

a. Statement of financial position
b. Income statement
c. Statement of cash flows
d. Statement of retained earnings

5. The major financial statements include all, except

a. Statement of financial position
b. Statement of changes in financial position
c. Statement of comprehensive income
d. Statement of changes in equity

6. When an entity changes the reporting period longer or shorter than

one year, an entity shall disclose all of the following, except
a. Period covered by the financial statements
b. The reason for using a longer or shorter period
c. The fact that amounts presented in the financial statements are
not entirely comparable
d. The fact that similar entities in the geographical area in which the
entity operates have done so

7. Which of the following is not a component of the financial

statements?
 a. Statement of financial position
b. Statement of changes in equity
c. Report of board of directors
d. Notes to financial statements

8. Which of the following is included in a complete set of financial

statements?
a. A statement by the board of directors of compliance with local
legislation
b. A statement of changes in equity
c. Statements of financial position for the last five years
d. Value added statement

9. Which of the following is included within the financial statements?

a. A statement of retained earnings
b. Accounting policies
c. An auditor’s report
d. Board of director’s report

10. An entity shall clearly identify each financial statement and

display all of the following, except
a. Name of the reporting entity
b. Names of major shareholders of the entity
c. The presentation currency
d. Whether the financial statements cover the individual entity or a
group of entities

11. Which of the following is incorrect concerning fair presentation

of financial statements?
a. Fair presentation requires the faithful representation of the effects
of transactions and other events
b. Financial statements shall present fairly the financial position,
financial performance and cash flows of an entity
c. In virtually all circumstances, a fair presentation is achieved by
compliance with applicable PFRS
d. An entity whose financial statement comply with PFRS shall not
make an explicit and unreserved statement of such compliance in
notes.
12. Which of the following cannot be considered fair presentation of
financial statements?
a. To present information in a manner that provides relevant and
faithfully represented financial information.
b. To provide additional disclosures when compliance with specific
PFRS is insufficient to understand the financial position and
financial performance
c. To select and apply accounting policies in accordance with
applicable PFRS
d. To rectify inappropriate accounting policies either by disclosure of
the accounting policies used or by notes or explanatory
information.

13. Which statement indicates a going concern?

a. Management intends to liquidate the entity
b. Management intends to cease the operations of the entity
c. Management has no realistic alternative but to cease the
operations of the entity
d. None of these would indicate going concern

14. An entity is permitted to depart from a particular standard if all

of the following conditions are satisfied, except
a. In extremely rare circumstances
b. When management concludes that compliance with the standard
would be misleading
c. When the departure from the standard is necessary to achieve fair
presentation.
d. When the Conceptual Framework for Financial Reporting prohibits
such a departure.

15. The effects of transactions and other events on economic

resources and claims are depicted in the periods in which those
effects occur even of the resulting cash receipts and payment occur
in a different period.
a. Accrual accounting
b. Cash accounting
c. Modified accrual accounting
d. Modified cash accounting
16. Financial statements must be prepared at least
a. Annually
 b. Quarterly
c. Semiannually
d. Every two years

17. Technically, offsetting in financial statements is accomplished

when
a. The allowance for doubtful accounts is deducted from accounts
receivable
b. The accumulated depreciation is deducted from property, plant
and equipment
c. The total liabilities are deducted from total assets
d. Gain or loss from disposal of noncurrent asset is reported by
deducting from the proceeds the carrying amount of the asset and
the related disposal cost.

18. The presentation and classification of items in the financial

statements shall b retained rom one accounting period to the next.
a. Consistency of presentation
b. Materiality
c. Aggregation
d. Comparability

19. A third statement of financial position as at beginning of the

earliest comparative period presented is required
a. When an entity applies an accounting policy retrospectively
b. When an entity makes a retrospective restatement of items in the
financial statements
c. When an entity reclassifies items in the financial statements
d. Under all of these circumstances

20. Which statement in relation to financial statements is incorrect?

a. General purpose financial statements do not and cannot provide
all of the information that primary users need
b. General purpose financial statements are designed to show the
value of the reporting entity
c. General purpose financial statements are intended to provide
common information to users
d. Financial statements are largely based on estimate and judgment
rather than exact depiction
21. Items of dissimilar nature or function
a. Must always be presented separately
b. Must not be presented separately
c. Must be presented separately if material
d. Must be presented separately even if immaterial

22. Materiality depends on

a. The nature of the omission or misstatement
b. The absolute size of the omission or misstatement
c. The relative size and nature of the omission or misstatement
judged in the surrounding circumstances
d. The judgment of management

23. The entity must disclose comparative information for

a. The previous comparable period for all amounts
b. The previous comparable period for all amounts and for all
narrative and descriptive information.
c. The previous comparable period for all amounts and for all
narrative and descriptive information when it is relevant to an
understanding of the current period’s financial statements.
d. The previous two comparable periods for all amounts.

24. When the classification of items in the financial statements is

changed, the entity
a. Must not reclassify the comparative amounts
b. Can choose whether or not to reclassify
c. Must reclassify the comparative amounts unless it is impracticable
to do so
d. Must reclassify the current year amounts only

25. An entity shall present

a. The statement of cash flows more prominently
b. The statement of financial position more prominently
c. The income statement more prominently
d. Each financial statement with equal prominence

26. The overall objective of financial reporting is to provide

information
a. That is useful or decision making
b. About assets, liabilities and equity
 c. About financial performance during a period
d. That assesses performance of management

27. The objective of financial reporting is based on

a. The need for conservatism
b. Reporting on management stewardship
c. Generally accepted accounting principles
d. The needs of the users of the information

28. Which is an objective of financial reporting?

a. To provide information that is useful in making investing and credit
decisions
b. To provide information that is useful to management
c. To provide information to investors
d. To provide information about internal and external conflicts

29. Which is an objective of financial reporting?

a. To provide information useful to management
b. To identify nonfinancial transactions
c. To provide information useful to assess the amount, timing and
uncertainty of prospective cash receipts
d. To provide information that excludes claims

30. An objective of financial reporting is to provide

a. Information about the investors in the entity
b. Information about the liquidation value of the entity
c. Information useful in assessing cash flow prospects
d. Information that will attract new investors.
31. During a period when an entity is under the direction of a
particular management, financial reporting will directly provide
information about
a. Entity performance and management performance
b. Management performance but not entity performance
c. Entity performance but not management performance
d. Neither entity nor management performance

32. Financial reporting pertains to

a. Individual business entities, rather than to industries or an
economy or to members of society as consumers
 b. Individual business entities and an economy or to members of
society as consumers
c. Individual business entities and an economy rather than to
industries or to consumers
d. Individual business entities, industries and an economy rather than
to members of society as consumers

33. Which is not an objective of financial reporting?

a. Financial reporting shall provide information about resources,
claims against resources and changes in them
b. Financial reporting shall provide information useful in evaluating
stewardship of management
c. Financial reporting shall provide information useful in investment,
credit and similar decision
d. Financial reporting shall provide information useful in assessing
cash flow prospects

34. Which is not an objective of financial reporting?

a. To provide information about assets and claims against those
assets
b. To provide information useful in assessing cash flows
c. To provide information useful in lending and investing decisions
d. To provide information about the liquidation value of an entity

35. Which would likely prepare the most accurate financial

forecasts for an entity based on empirical evidence?
a. Investors using statistical models
b. Corporate management
c. Financial analysts
d. Independent certified public accountants

36. What is the most useful information in predicting future cash

flows?
a. Information about current cash flows
b. Current earnings based on accrual accounting
c. Information regarding the accounting policies used
d. Information regarding the results obtained by using a wide variety
of accounting policies.

37. The accrual basis of accounting is most useful for

 a. Determining the amount of income tax liability
b. Predicting short-term financial performance
c. Predicting long-term financial performance
d. Determining the amount of dividends to shareholders

38. In measuring financial performance, accrual accounting is used

because
a. Cash flows are considered less important
b. It provides a better indication of ability to generate cash flows than
cash basis
c. It recognizes revenue when cash is received and expenses when
cash is paid
d. It is one of the implicit assumptions

39. The financial statements prepared under GAAP

a. Do not articulate with one another
b. Reflect a single measurement which is historical cost
c. Are not highly precise because estimate and judgment must be
made
d. Contain a limited number of future projections