THE BASIC FINANCIAL STATEMENT

Financial statements and their accompanying notes contain a wealth of useful information
regarding the financial position of a company, the success of its operation, the policies and
strategies of management, and insight into its future performance.

The four basic financial statement :

1. Statement of financial position- show the financial position- assets, liabilities and owner’s
equity of the firm on a particular date such as the end of a quarter or a year.
2. Income or earnings statement- represents the result of operations- revenues, expenses, net
profit or loss, for the accounting period.
3. Statement of changes in equity- summarizes the changes in a company’s equity for a
period of time (generally one year).
4. Cash flow statement- provides information about the cash inflows and outflows from
operating , financing and investing activities during an accounting period.

CONCEPTUAL FRAMEWORK FOR THE PREPARATION AND PRESENTATION OF

FINANCIAL STATEMENTS
 Financial reporting standards- set of standards or rules applied by accountants in
preparing financial statements. It allows for significant latitude in how certain
transactions should be accounted for, meaning that professional judgements is
particularly important.

QUALITATIVE CHARACTERISTICS OF ACCOUNTING INFORMATION

 In order to justify providing accounting information, the benefit which may derived from
the use of this information must exceed the cost of providing the data.
 There are several cost of providing information:
1) Cost of collecting, processing and disseminating.
2) Cost of auditing.
3) Costs associated with dangers of litigation and loss of competitive advantage.
4) Costs to the user for analysis and interpretation.

THE STATEMENT OF FINANCIAL POSITION

 It shows the financial condition or financial position of a company on a particular date.
 A summary of what the firm owns (assets) and what the firm owes to outsider (liabilities)
and to internal owners (stockholder’s equity)
 CURRENT ASSETS
 Include cash or those assets expected to be converted into cash, used or consumed within
one year or one operating cycle whichever longer.
 Operating cycle- the time required to purchase or manufacture inventory, sell the product
and collect the cash.
 Working capital/net working capital- used to designate the amount by which current
assets exceed current liabilities (current asset less current liabilities).
CASH AND CASH EQUIVALENT

 The cash account is exactly that, cash in any form – cash awaiting to deposit or in a bank
account.
 Cash equivalents- are short-term and highly liquid investment that are readily convertible
to cash.
MARKETABLE SECURITIES
 Are cash substitutes, cash that is not needed immediately in the business and is
temporarily invested to earn a return. These investments are instruments with short-term
maturities (less than one year) to minimize the risk of interest rate fluctuations.
ACCOUNTS RECEIVABLE
 Customer balances outstanding on credit sales and are reported on the statement of
financial position at their net realizable value, that is, the actual amount of the account
less an allowance for doubtful accounts.
INVENTORIES
 Items held for sale or used in the manufacture of products that will be sold.
 Three different types of inventories: Raw material or supplies, work-in process, and
finished goods.
PREPAID EXPENSES
 Certain expenses, such as insurance, rent, property taxes and utilities are sometimes paid
in advance. They were included in current assets if they will expire within one year or
one operating cycle, whichever is longer.
PROPERTY, PLANT AND EQUIPMENT

 Encompasses a company’s fixed assets (also called tangible, long-lived, and capital
assets). These assets produced economic benefits foe more than one year. Fixed assets are
depreciated over the period of time they benefit the firm.
  Depreciation- method of allocating the cost of long-lived assets.

OTHER NONCURRENT ASSETS

1. Property held for sale
2. Cash surrender value of life insurance policies
3. Long-term advanced payments
4. Long-term investment
5. Intangible assets (Goodwill, patents, trademarks, copyrights, brand names and franchises)

CURRENT LIABILITIES
 Liabilities represents against assets, and current liabilities are those that must be satisfied
in one year or one operating cycle, whichever is longer. Current liabilities include
accounts and notes payable, the current portion of long-term debt, accrued liabilities and
deferred taxes.
ACCOUNTS PAYABLE
 Short-term obligations that arise from credit extended by suppliers for the purchase of
goods and services.
NOTES PAYABLE
 Short-term obligations in the form of promissory notes to suppliers for the financial
institutions.
CURRENT MATURITIES OF LONG-TERM DEBT
 The note lists the amount of long-term debt outstanding, less the portion due currently.
ACCRUED LIABILITIES
 Result from the recognition of an expense in the accounting record prior to the actual
payment of cash.

NONCURRENT LIABILITIES
 These are obligations with maturities beyond one year.
1) Bonded indebtedness
2) long-term notes payable
3) mortgages
4) obligations under leases
 5) pension liabilities
6) deferred taxes

 Deferred tax liabilities- amounts of income taxes payable in future period.

EQUITY
 Ownership Equity- is the residual interest in the assets that remain after deducting
liabilities.
 Owners- bear the greatest risk because their claims are subordinate to creditors in the
event of liquidation
SHARE CAPITAL
 Amount listed under share capital is based on the par or stated value of the shares issued.
ADDITIONAL PAID-IN CAPITAL
 This account reflects the amount by which the original sales price of the stock shares
exceeded par value as well as from other sources such as donated capital and treasury
stock transactions.
RETAINED EARNINGS
 The sum of every peso a company has earned since its inception, less any payments made
to shareholders in the form of cash or stock dividends.
 Funds a company has elected to reinvest in the corporate vaults.
 Measurement off all undistributed earnings.

OTHER EQUITY ACCOUNTS

1) Preferred Stock
2) Foreign currency transaction effects
3) Treasury Stock
4) Accumulation of unrealized gains or losses on investment in debt

INCOME STATEMENT
 One of many pieces of a financial statement package
 Earnings- Measured on an accrual rather than a cash basis, which means that income
reported on the income statement is not the same as cash generated during the accounting
period.
 Two basic formats of income statement
 1) Multiple-step- provides several intermediate profit measures (gross profit,
operating profit, and earnings before income tax) prior to the amount of net
earnings for the period.
2) Single-step- version of the income statement group all items of revenue, then
deducts all categories of expense to arrive at a figure for net income.
 Discontinuing Operations- occurs when a firm sells a major portion of its business.

NET SALES
 Sales return- cancelation of sales.
 Sales allowance- deduction from the original sales invoice price.
COST OF GOODS SOLD/COST OF SALES
 The first expense deduction from sales is the cost to the seller of the products sold to
customers.
 Cost of goods sold percentage- relationship between cost of goods sold and net sales.
GROSS PROFIT/GROSS MARGIN
 The difference between net sales and cost of goods sold.
 The first step of profit measurement on the multiple-step income statement and is a key
analytical tool in assessing a firm’s operating performance.

OPERATING EXPENSE
 These are all areas over which management exercises discretion and which have
considerable impact on the firm’s current and future profitability.
1) Selling and administrative expenses- expenses that relate to the sale of products
or services and to the management of the business.
2) Advertising cost- a major expense in the budgets of companies for which
marketing is an important element of success.
3) Lease payments- includes the cost of rentals of leased facilities for rental
outlets.
4) Depreciation and Amortization
 Depreciation- used to allocate the cost of tangible fixed assets such as
buildings, machinery, equipment, furniture and fixtures, and motor vehicles. It
is calculated principally by straight -line method based upon estimated useful
lives for buildings.
 Amortization- the term applied to the cost expiration of intangible assets such
as patents, copyrights, trademarks, licenses, resources-oil and gas, other
minerals, and standing timber-is allocated through depletion.
5) Repair and maintenance- the annual cost of repairing and maintaining the
property, plant and equipment.
OPERATING PROFIT
 Also called EBIT or earnings before interest and taxes.
 The second profit determination and measures the overall performance of the company’s
operation: sales revenue less the expenses associated with generating sales.

OTHER INCOME (EXPENSES)

1. Dividend and interest income
2. Interest expense
3. Gains (losses) from investments
4. Gains (losses) from the sales of fixed assets
EARNINGS BEFORE INCOME TAXES
 Is the profit recognized before the deduction of income
NET EARNINGS

 Represents the firm’s profit after the consideration of all revenue and expense reported
during the accounting period.
EARNINGS PER ORDINARY SHARE
 Is the net earnings for the period divided by the average number of ordinary shares
outstanding.

THE STATEMENT OF CHANGES IN EQUITY

As prescribed in PAS 1, an enterprise should present as a separate component of financial
statements , along with the traditional financial statement, a statement showing
a) The net profit or loss for the period;
b) Items of income (including gain) and expenses (including loss) which are recognized in
equity, as required by this standard, and the total of these items;
c) The cumulative effect of changes in accounting policy and the correction of fundamental
errors (when the benchmark treatment, retrospective application and adjustment of
beginning retained earnings, respectively, is selected under PAS 8);
d) Capital transactions and distributions with/to owners of the enterprise;
e) The balance of accumulated profit or loss at the beginning of the period and at the
statement of financial position date, and the movement for the period; and
 f) A reconciliation between the carrying amounts of each class of equity capital, share
premium and each reserve at the beginning and the end of period, separately disclosing
each movement.
THE CASH FLOW STATEMENT
 Required by PAS 7
 Provides information bout cash inflows and outflows.
 It segregates according to operating activities, investing activities and financing activities.
 As enterprise should report cash flows from operating activities using either:

1. Direct method whereby major classes of gross cash receipts and gross cash
payments are disclosed.
2. Indirect method whereby net income or loss is adjusted for the effects of
transactions of non cash nature, any deferrals or accruals of past or future
operating cash receipts or payments, and items of income or expense associated
with investing or financial cash flows.
CASH FLOW FROM OPERATING ACTIVITIES
 Operating activities are principal revenue-producing activities of an enterprise and
include delivering of producing goods for sale and providing services.

CASH FLOW FROM INVESTING ACTIVITIES

 These includes cash effects of transactions involving acquiring and selling or otherwise
disposing of:
1. Securities that are not cash equivalents.
2. Productive assets and payments that are expected to benefit for long period of
time.
 Investing activities also include:
1. Cash advance and collection on loans made to other parties.
2. Cash payment and receipts for future contracts, formal contracts, are held for
dealing and trading purposes or the payments or receipts are classified as
financing activities.

CASH FLOW FROM FINANCING ACTIVITIES

 Financing activities include obtaining resources from and returning resources to owners
as well as obtaining resources through borrowings (short-term or long-term) and
repayments of the amounts borrowed.
CHALLENGES AND OBSTACLES CONFRONTING THE USER OF FINANCIAL
STATEMENTS
 Volume of information
 Complexity of the accounting rules
 Variation in the quality of financial report
 Impact of inflation of financial statement data
 Omission or difficult to find financial information
VOLUME OF INFORMATION
 The users of a firm’s annual report usually encounters a great quantity of information that
encompasses the required information such as:
a) Financial statement
b) Notes to the financial statements
c) The auditor’s report
d) Summary of key financial data
e) High and low stock prices
f) Management’s discussion and analysis of information
g) Effect on foreign currency translation
h) Segmented data and other
COMPLEXITY OF ACCOUNTING RULES
 Financial statements are prepared according to Philippine Financial reporting standards
that have been adopted in order to achieve a presentation of financial information that in
both understands by users and relevant for decision making,
QUALITY OF FINANCIAL REPORTING
1. Management can make choices with respect to accounting policies and make
estimations in the application in these policies.
2. Management can exercise discretion regarding the timing of the expense and revenue
recognition.
3. Many of the expenditure made by a business firm discretionary.
4. Existence of nonrecurring and non-operating items.

IMPACT OF INFLATION
 Changing prices can erode the usefulness of financial statements.
 The new Philippine financial reporting standards allows the recognition of statement of
financial position accounts at fair value not net realizable value, present value or in a case
of property, plant and equipment, its recoverable amount if it is less than the carrying
amount, historical or original transaction cost remains the more predominant basis of
recording and valuing assets and liabilities
MISSING AND DIFFICULT TO FIND INFORMATION
1) Intangible as employees relation with management
2) The morale and efficiency of employees
3) The reputation of the firm with its customers
4) Its prestige in the community
5) The effectiveness of management
6) Potential exposure to change in regulation

CHAPTER III
UNDERSTANDING
FINANCIAL STATEMENTS
AILENE BARQUEZ
LHENEIL JANE BARROZO
LALAINE COLLADO
VINCENT DEL ROSARIO