MODULE 2

FINANCIAL STATEMENTS BASED ON

PHILIPPINE ACCOUNTING STANDARDS
(PAS) #1

INTENDED LEARNING OUTCOMES

At the end of the lesson, the students will be able to:

 Know and explain the definition and components of the financial

statements;
 Know and explain the relationship of the components of financial
statements; and
 Prepare the basic financial statements.

INTRODUCTION

Every now and then, accounting is coined as the language of finance. The
reason for this is its inherent nature of providing financial information through the
formal reports prepared by accountants. These formal reports are called financial
statements. These statements present the consequences of business events or
transactions, split and classified according to its financial nature.

According to PAS≠1, an accomplished collection of financial statements would

include the following:

 Statement of Financial Position (Balance Sheet)

 Income Statement
 Statement of Comprehensive Income
 Statement of Change in Equity
 Statement of Cash Flows
 Notes to the Financial Statements

The same PAS made changes in the titles of financial statements in order to
mirror their specific functions. The income statement presents the report on income
and expenses, the statement of cash flows presents the movement of cash to and
from the company. The balance sheet’s name is changed to statement of financial
position because, the world balance sheet does not reflect what is found in the

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statement. A balance of what, hence the change of the name. The statement of
financial position is a better name since it tells the user what can be found in the
report.

The financial statements’ foremost objective is to provide information

concerning the financial position, performance and cash flows of a company needed
by various users in making sound economic decisions.

LET’S LEARN

STATEMENT OF FINANCIAL POSITION (SFP)

As the name connotes, this financial statement present the company’s financial
position at a given period. It consists of the three elements making the financial
position – assets, liabilities and equity.

Users of this statement, current as well as potential investors, current as well as

potential creditors, and the firm’s management, utilize it in evaluating the company’s
liquidity, solvency, financial structure, and capacity for adaption.

Assets and their Classification

The definition of assets includes its essential features. The underlined word(s)
pertain to their essential characteristic. Assets are “resources controlled by the entity
as a result of past transactions and events from which future economic benefits are
expected to flow in the entity.” For assets to be recognized for recording, the cost of
the asset should be measured reliably.

The PAS ≠1 classifies assets as current and non-current. Assets are

considered to be current: (1) when its is cash or cash equivalent; (2) when the
company intends to hold the asset for the purpose of trading it; (3) when the company
expects to realize the asset within 12 months; and (4) when the company expects to
realize the asset or intends to sell or use it within the entity’s normal operating cycle.
The current assets are typically arranged in the order of liquidity. The line items in the
current assets can be seen in the sample SFP.

The non-current assets take the residual definition. This means that if the asset
does no fall under current asset then it must be non-current. Items included in the
non-current assets are seen in the sample SFP.

Liabilities and their Classification

The firm’s liabilities are the present obligations of the firm from past transactions
or events, the payment of which is expected to result in an outflow of economic
resources to assets.

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 The PAS ≠1, par. 69 classifies liabilities as current and non-current. One of the
criteria for one to classify liabilities as current is when the firm is expected to pay the
liability within its normal operating cycle. Another criteria is when the firm holds the
liability primarily for the purpose of trading, also when the liability can be paid within
twelve months.

The non-current liabilities also take the residual definition. Liabilities not
classified not as current are non-current. The presentation of the current and non-
current liabilities is also found in the same SFP.

Shareholders’ Equity (SHE) and its Components

The shareholders’ equity or simply Equity in its raw meaning is the excess of
the firm’s assets over the firm’s liabilities. The shareholders’ equity of a corporation
has three basic components, namely the share capital, reserves and retained
earnings.

Share capital component of the SHE consists of the issuance of the company’s
own share at their par or stated value.

The reserves components of issuance of the company’s own share above

par/stated value or additional paid in capital or sometimes called premium on share
capital. The other reserve component may consist of various comprehensive income,
revaluation surplus, and appropriated retained earnings.

The last component of the SHE is the Retained Earnings. This component
consists of, among other things, the accumulated earnings of the company, prior
period adjustment for errors, dividends declared/paid, effect of changes in accounting
policy and appropriated retained earnings. The components of the SHE are presented
in the statement of changes in equity.

Before going to the next sub-topic, the Income Statement, please look at the
sample statement of financial position. Observe the presentation closely. Observe the
heading, the classification, the items found in each classification and how they are
arranged. Familiarize yourself with them.

INCOME STATEMENT AND ITS FORMS

This statement presents the result of the firm’s operation or performance for a
given time. Elements found in the statement consist of revenue and expenses. In the
provisions of PAS ≠1, it mentioned that a business shall present the income statement
by using either the functional approach (cost of sales method) or natural approach.

The functional presentation follows the function of expenses, while the natural
approach considers the nature of expense. Under the functional approach the
expenses are classified in accordance with their function namely, cost of sales, selling
expenses, administrative expenses and other expenses. This is the typical income
statement format used by most companies.

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 The expenses under the natural approach are clustered according to their
nature. All revenue items are clustered and totalled. All expenses are cluster and
totalled. The sum of the expenses are deducted from the sum of revenues to get the
income before tax.

STATEMENT OF COMPREHENSIVE INCOME

What is comprehensive income? This could be better understood by knowing

its components. Generally, comprehensive income consists of recognized gains and
losses that are not included in the income statement but are found in the equity section
of the SFP or more clearly at the statement of changes in equity.

You might ask, if these are gains or losses why then are they not found in the
income statement? Why are they found in the equity section of the SFP?

The statement of comprehensive income can be presented separately or can

be presented as an extension of the income statement. When the comprehensive
income is included in the income statement, the income statement heading is no
longer used. Instead the income statement shall be called statement of
comprehensive income. See the presented example of this statement.

STATEMENT OF RETAINED EARNINGS

The results of the current year’s operation bring about changes in the
company’s retained earnings. These changes are disclosed in the statement of
retained earnings. This statement link the income statement results to the SFP.

STATEMENT OF CHANGES IN EQUITY

The development or changes that occur in the shareholders’ equity are

presented in the statement of changes in equity. The following are presented in this
statement:

1. The total or net comprehensive income.

2. Effects brought about by the changes in accounting policies or correction of
errors.
3. Investment transactions of owners and dividends paid to owners.
4. The beginning balance of each component in the statement of changes in
equity and the movements under them that brought about the ending balances.

This concepts are made clear by observing the statement of changes in equity sample.

STATEMENT OF CASH FLOW (Based on PAS 7)

The summary of the operating, investing and financing activities of the firm is
presented in the statement of cash flows. This statement reconciles the beginning and

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ending balances of cash and cash equivalents in the SFP. The ending balance of the
statement of cash flows is the same as the cash balance presented in the balance
sheet. In other words, this statement shows the movements (receipts and
disbursements) of cash for one whole period, generally one year.

Cash flows and its classification

Cash flows refer to the movement of cash. It could either be an inflow of cash
which pertains to receipts of cash or an outflow which means disbursement of cash.

In presenting the cash flow for the period, the movement of cash shall be
categorized as cash flows from:

Operating activities. These are activities related in the generation of the

principal revenue of the firm. Principal revenue means the main source of revenue or
income for the company. For instance, selling activities are the principal source of
revenue of merchandising firms. Therefore, cash sales is a source of cash inflow from
operating activities. Among the other examples of cash flows from operating activities
may include:

 Cash receipts from rental fees, service fee, professional fees, legal fees,
tuition fee, etc.
 Cash used to pay salaries, utilities, purchases, and payables.
 Cash receipts or disbursement from securities kept by the company, for
dealing or trading. They are like merchandise held for sale.

Investing activities. These are cash flows from purchasing or selling long-
term assets and other long-term investments. Basically, these are cash flows from
sale or purchase transactions wherein non-operating assets (assets other than
inventory) are involved. Examples of cash flows from investing activities would be.

 Cash disbursements used to buy buildings, plants, equipment, furniture

and other fixed assets.
 Cash receipts or payments from derivative transactions like future or
forward contracts, swap contracts and option contracts.
 Cash receipts or payments from selling or buying of equity securities or
shares or debt instruments like bonds of other companies for short-term
or long-term purposes.

Financing activities. These are the company’s cash inflows or outflows

involving its owners (equity financing) and creditors (debt financing). The borrowings
included under this category are non-trade payables. Non-trade payable are those we
get from borrowings from bank or other financial institutions. These are not from
purchases of inventory or company office or store supplies. Examples of these
activities include:

 Cash receipts from issuance of the company’s ordinary shares, and preferred
shares.
 Cash disbursements used to pay acquisition of treasury shares or redeemable
preferred shares.

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  Cash receipts from issuing the company’s bond notes.
 Cash receipts from short-term loans payable, bank payables, or mortgage
payables.
 Cash disbursement used to pay bank loan and other form of borrowings.

Illustrative Example of Financial Statements

The consolidated financial statements provided here, is industry-based. It is

taken from a world-renowned corporation belonging to the fuel industry. The accounts
are industry-based, however the amounts are assumed figures. It is important to
remember that financial statements may vary from one industry to another.
Consolidated financial statements, as the name connotes, is a consolidation of
financial statements made by a firm with subsidiaries. Subsidiaries are independent
corporations that exist independently from their parent corporation. The parent firm is
the corporation that holds controlling ownership over its subsidiaries.

ADA Corporation and Subsidiaries

Consolidated Statement of Financial position
December 31, 2007
(Amount in Million Pesos)

Note
Assets
Current Assets
Cash and Cash Equivalent 4 P9,732
Trading Securities 5 229
Available-for-sale investments (due in one year
Or less) 6 164
Trade and other Receivables - net 7 17,869
Inventories-net 8 30,271
Other current assets 11 10,315
Total Current Assets P68,580
Non-Current Assets
Available-for-sale investments (due after one
Year to five years) 6 468
Property, Plant and Equipment - net 9 34,128
Investment Properties - net 10 202
Deferred tax assets - net 22 885
Other non-current assets 11 211
Total Non-current Assets 35,894
Total Assets P104,474
========
Liabilities and Equity
Current Liabilities
Short-term Loans 12 P33,784
Liabilities for crude oil and petroleum importation 23 12,873
Trade and other payables 13 4,544

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 Income tax payable 523
Bank loan payables – Current portion - net 14 1,604
Total Current Liabilities P53,328
Non-current Liabilities
Bank loan payables – net of current portion 14 11,176
Deferred tax liabilities - net 22 1,268
Other non-current liabilities 15 914
Total Non-current Liabilities 13,358
Total Liabilities 66,686
Equity Attributable to Equity Holders of the Parent
Company
Share Capital 16 9,375
Retained Earnings 16 28,692
Other reserves (412)
Total Equity Attributable to Equity Holders of the
Parent 37,655
Minority Interest 133
Total Equity P37,788
Total Liabilities and Equity P104,474
========

ADA Corporation and Subsidiaries

Consolidated Income Statement
For the Year Ended December 31, 2007
(Amount in Million Pesos, Except Per Share Amounts)

Note
Sales 26 P210,520
Less: Cost of Goods Sold 17 195,287
Gross Profit P15,233
Less: Expenses:
Selling and Administrative Expenses 18 5,325
Interest Expense 21 1,814
Interest Income 21 (344)
Others - net 21 (912)
Total Expenses 5,883
Net Loss before tax P9,350
Less: Tax Expense (Benefit) 23/32
Current 3,165
Deferred (210) 2,955
P6,395
NET INCOME
======
Earnings (loss) per share 27 P0.68

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 ADA Corporation and Subsidiaries
Consolidated Statement of Comprehensive Income
For the Year Ended December 31, 2007
.
Note
Net Income for the year P6,395
Other Comprehensive Income:
Actuarial Gain on defined pension plan 25 88
Unrealized fair value gain (loss) on available-for-sale
investments (net of tax effects of P5) 6 (9)
Exchange difference in translating foreign
operations (1)
Total Other Comprehensive Income (loss), net of tax 78
P6,473
TOTAL COMPREHENSIVE INCOME
======

ADA Corporation and Subsidiaries

Consolidated Statement of Changes in Equity
For the Year Ended December 31, 2007

Retained Earnings
Share
Notes Approp. Unapprop. Others Total
Capital
Balance at January 1,
2007 16 P9,375 P17,021 P6,232 P(490) P32,138
Total comprehensive
income for the year 6,377 78 6,455
Appropriations for
capital projects 16 4,151 (4,151)
Cash Dividends – P0.10
per share 16 (938)
Balance at December
P9375 P21,172 P7,520 P(412) P37,655
31, 2007
===== ======= ====== ====== =======

ADA Corporation and Subsidiaries

Consolidated Statement of Cash Flows
For the Year Ended December 31, 2007

Note
CASH FLOWS FROM OPERATING ACTIVITIES
Income before tax P9,350
Adjustments for:
Depreciation and amortization 20 2,516
Interest Expense 21 1,814
Unrealized Foreign exchange gain - net (520)

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 Interest Income 21 (344)
Others (81) 3,385
Other income before working capital changes P12,735
Changes in operating assets and liabilities 28 (2,637)
Interest paid (1,680)
Income taxes paid (3,098)
Interest received 343
Net Cash Provided by Operating Activities P5,663

CASH FLOWS FROM INVESTING ACTIVITIES

Disposals of (Additions to):
Property, Plant and Equipment 9 P(11,477)
Investment Properties 10 6
Decrease (Increase) in:
Other Receivables 7 (956)
Other non-current assets 5
Reductions from (additions to):
Available-for-sale investments (9)
Net Cash Used in Investing Activities P(12,431)

CASH FLOWS FROM FINANCING ACTIVITIES

Proceeds from availment of loans 69,625
Payments of:
Loans (63,789)
Cash Dividends (927)
Others (134)
Net Cash Provided by Financing Activities P4,775
Effects of Exchange Rate Changes on Cash and Cash
Equivalents (10)
Net Increase (Decrease) in Cash and Cash
Equivalents (2003)
Cash and Cash Equivalents at the beginning of the
year 11,735
P9,375
CASH AND CASH EQUIVALENTS AT END OF YEAR
======

NOTES TO THE FINANCIAL STATEMENTS

There are bits or sets of information that cannot be disclosed on the face of the
financial statements. This information may be either be quantitative or qualitative in
nature and may have a bearing on how the financial statements may be interpreted.
Since they are not found on the face of the financial statements and have a bearing in
interpreting the financial statements, they are placed to the notes to the financial
statement section of the auditor’s report.

The notes may include (indicated as a subheading) the following:

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  Corporate/Company Information. This may include the nature of the
business, the associates of subsidiaries of the company, and the principal
activities of the company.

 Basis of Preparing the Financial Statements and the Statement of

Compliance (when segregated from the Summary of Significant Accounting
Policies). The basis in preparing the financial statements could be at historical
cost or at fair value. The preparation of the financial statements should be in
compliance with the Philippine Financial Reporting Standards (PFRS).

 Summary of Significant Accounting Policies. The significant accounting

policies used by the company in carrying out their operations and preparing
their financial statements. The changes in accounting policies may also be
included here or placed in a segregate heading. The breakdown of the line
items in the financial statements is also included under this subheading. For
example the Trade and other Receivables in the face of the SFP is broken
down in detail and the total is the one shown in the SFP.

The main objectives for preparing the notes is to supply the users of the financial
statements the necessary disclosures as required by the Philippine Financial
Reporting Standards (PFRS).

Presented below are selected of the notes to the financial statement. This
would give you an idea on what the notes contain.

Excerpts from the Notes to Financial Statements (ADA Corporation)

Corporate/Company Information:

The firm was incorporated under the laws of the Republic of the Philippines and
registered with the Philippine Securities and Exchange Commission (SEC) on July 22,
1966. ADA is considered the larges oil refining and marketing company in the
Philippines. It supplies more than 1/3 of the nation’s fuel requirements.

Basis of Preparing the Financial Statements

The accompanying financial statements of ADA Corporation and subsidiaries

were prepared on a historical cost basis, except for the financial assets, available-for-
sale (AFS) investments and derivative financial instruments, which are measured at
fair value. The consolidated financial statements are presented in Philippine peso,
which is the firm’s functional and presentation currency. All amounts are rounded to
the nearest millions, except when otherwise indicated.

Statement of Compliance

The consolidated financial statements of the firm were prepared in compliance

with Philippine Financial Reporting Standards (PFRS).

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Summary of Significant Accounting Policies

 Trade and other Receivables

Trade P12,779
Government 4,440
Others 1,374
Total P18,593
Less: Allowance for Impairment loss 724
Net Realizable value P17,869
=======

 Inventories

At Cost:
Petrolium P12,358
Crude Oil and Others 17,332
At net realizable value 581
Inventories - net P30,271
=======

 Trade and Other Payables

Accounts Payable P2,653

Accrued Expenses 957
Specific Taxes and other taxes payable 443
Others 491
Total P4,544
======

 Other Non-current Liabilities

Asset retirement obligation P461

Cylinder Deposits 243
Cash bonds 173
Others 37
P914
Total
====

 Equity

Number of Shares
Authorized = P1.00 per value P10,000,000 P10,000
Issued and Outstanding 9,375,104,497 P9.375

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 Cost of Goods Sold

Inventories P191,613
Depreciation & Amortization (see note 20) 1,538
Employee Costs 463
Others - net 1,673
P195,287
Total
========

 Selling and Administrative Expenses

Employee costs P1,481

Purchased services and utilities 994
Depreciation & Amortization 978
Maintenance and repairs 530
Advertising 495
Rent 395
Materials and office supplies 188
Taxes and Licenses 120
Impairment loss and trade and other
receivables 50
Expenses related to all incident 15
P5,325
Total
======

 Earnings Per Share

Net income attributed to shareholders of

the parent company P6,377
Weighted average number of shares 9,375,104,497
Basic and diluted EPS P0.68
=====

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 LET’S SEE WHAT YOU HAVE LEARNED

Activities

Concept Discussion

Briefly discuss the following:

1. The components of the financial statements.

2. Classification of Current and Non-Current Assets
3. Classification of Current and non-Current Liabilities
4. Components of the Shareholders’ Equity
5. Comprehensive income
6. Statement of Cash Flows

Concept Application:

Problem 1:

From the account balance given below for Surf Corp. you are tasked to prepare
the statement of financial position. Observe proper classifications. In thousand pesos.

Account Receivable P400

Advances to officers not currently collectible 100
Sinking fund 400
Building 5,000
Long-term refundable deposit 50
Cash and cash equivalent 500
Cash surrender value 60
Equipment 1,000
Lease rights 100
Accrued interest income 10
Inventories 1,300
Land 1,500
Land held for speculation 500
Notes receivable 250
Computer software 3,250
Prepaid expenses 70
Trading securities 280
Unearned rent income 40
Retained Earnings (deficit) (1,800)
Share premium-preference share 500
Premium on bonds payable 1,000
Preference share capital 2,000

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 Share premium - ordinary 200
Notes payable 300
SSS Payable 10
Accounts payable 400
Accrued salaries 100
Accumulated depreciation – building 2,000
Accumulated Depreciation - equipment 200
Allowance for doubtful accounts 20
Bonds payable 5,000
Dividends payable 120
Ordinary share capital 5,000
Withholding tax payable 30
Preference share redemption fund 350

Problem 2:

From the 2015 account balances given below for Karla Corporation you are
tasked to prepare the Income Statement (functional approach). Observe proper
classifications.

Freight - In P1,000,000
Income Tax 500,000
Purchases 10,500,000
Purchase returns 150,000
Purchase allowances 150,000
Rent Income 500,000
Freight - Out 350,000
Salesmen’s commission 1,300,000
Depreciation Expense – Store equipment 250,000
Inventory (January 1) 2,000,000
Inventory (December 31) 3,000,000
Sales 15,700,000
Sales Returns 250,000
Sales Allowances 30,000
Sales discounts 20,000
Officer’s Salaries 1,000,000
Depreciation expense – office equipment 600,000
Purchase Discounts 200,000
Dividend Income 300,000
Loss on sale of equipment 100,000
Loss on sale of investment 100,000

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Researched Based Learning Activity:

1. Research on the latest financial statements issued by various industries

(choose one):

1.1 Banking
1.2 Manufacturing
1.3 Hotel and Restaurant
1.4 Cooperatives
1.5 Educational Institutions
1.6 Public Utilities (PLDT, NAPOCOR, ZAMCELCO, and the like)

2. Based on the financial statements you have researched, thoroughly discuss

your observations on the financial statements. Your discussions can focus on
the following:
2.1 What financial statements are reported by the company?
2.2 On the Statement of Financial Position:
2.2.1 The preparation and classification used in the presentation of the
Statement Financial Position (SFP); and
2.2.2 The accounts included in the Statement of Financial Position (SFP).
2.3 On the Income Statement:
2.3.1 The form of the Income Statement used by the company; and
2.3.2 The accounts and the arrangement as presented in the income
statement.
2.4 On Comprehensive Income:
2.4.1 Discuss how the comprehensive income was presented.
2.4.2 What items formed part of the comprehensive income?
2.5 On the Statement of Changes in Equity:
2.5.1 Discuss how the statement was presented.
2.5.2 What items worth noting were included in the statements?
2.6 On the Cash Flow Statement:
2.6.1 Discuss how the Cash Flow Statement Presented.
2.6.2 What items worth noting were included in the statements?
2.7 On the Notes to the Financial Statements:
2.7.1 Discuss the outline in the presentation of the notes to Financial
Statements.
2.7.2 What salient items are worth noting in the preparation of the notes to
the Financial Statements?

Note: Please keep the financial statements you have researched from this chapter.
You will still be using them for the next two chapters.

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