CHAPTER 4: CONCEPTUAL FRAMEWORK – Financial Statements and Reporting Entity

Underlying Assumptions

General objective of Financial Statements

Financial statements provide information about economic resources of the reporting entity, claims
against the entity and changes in the economic resources and claims.

The financial information is provided in the following:

1. Statement of financial position, by recognizing assets, liabilities and equity.

2. Statement of financial performance, by recognizing income and expenses.
3. Other statements and notes by presenting and disclosing information about:
a) Recognized assets, liabilities, equity, income and expenses
b) Unrecognized assets and liabilities
c) Cash flows
d) Contribution from equity holders and distribution to equity holders
e) Method, assumption and judgment in estimating amount presented

Types of Financial Statements

The Revised Conceptual Framework recognizes three types of financial statements.

1. Consolidated financial statements – These are the financial statements prepared when the
reporting entity comprises both the parent and its subsidiaries.
2. Unconsolidated financial statements – These are the financial statements prepared when the
reporting entity is the parent alone.
3. Combined financial statements – These are the financial statements when the reporting entity
comprises two or more entities that are not linked by a parent and subsidiary relationship.

Reporting entity

A reporting entity is an entity that is required or chooses to prepare financial statements. It can be a
single entity or portion of an entity, or can comprise more than one entity.

A reporting entity is not necessarily a legal entity.

Reporting period

The reporting period is the period when financial statements are prepared for general purpose financial
reporting. Financial statements may be prepared on an interim basis, for example, three months, six
months or nine months.

Financial must at least be prepared on an annual basis or a period of twelve months.

Financial statements are prepared for a specified period of time and provide information about:

a) Assets, liabilities and equity at the end of the reporting period

b) Income and expenses during the reporting period
Underlying assumptions

Accounting assumptions are the basic notions or fundamental premises on which the accounting process
is based. They are also known as postulates.

The Conceptual Framework for Financial Reporting mentions only one assumption, namely going
concern.

However, implicit in accounting are the basic assumptions of an accounting entity, time period and
monetary unit.

Going concern

The going concern or continuity assumption means that in the absence of evidence to the contrary, the
accounting entity is viewed as continuing in operation indefinitely.

The going concern postulate is the very foundation of the cost principle.

Accounting entity

In financial accounting, the accounting entity is the specific business organization, which may be a
proprietorship, partnership or corporation.

Under this assumption, the entity is separate from the owners, managers, and employees who constitute
the entity.

Each business is an independent accounting entity.

Time period

The time period assumption requires that the indefinite life of an entity is subdivided into accounting
periods which are usually of equal length for the purpose of preparing financial reports on financial
position, performance and cash flows.

By convention, the accounting period or fiscal period is one year or a period of twelve months.

A calendar year is a twelve-month period that ends on December 31.

A natural business year is a twelve-month period that ends on any month when the business is at the
lowest or experiencing slack season.

Monetary unit

The monetary unit assumption has wo aspects, namely quantifiability and stability of the peso.

The quantifiability aspect means that the assets, liabilities, equity, income and expenses should be
stated in terms of a unit of measure which is the peso in the Philippines.

The stability of the peso assumption means that the purchasing power of the peso is stable or constant
and that its instability is insignificant and therefore may be ignored.

The stable peso postulate is actually an amplification of the going concern assumption so much so that
adjustments are unnecessary to reflect any changes in purchasing power.
The accounting function is to account for nominal pesos only and not for constant pesos or changes in
purchasing power.

In today’s world, the assumption that the peso is a stable measure over time is not necessarily valid.

MULTIPLE CHOICE THEORIES

1. What is the only underlying assumption mentioned in the Conceptual Framework for Financial
Reporting?

a. Going concern
b. Accounting entity
c. Time period
d. Monetary uuni

2. Which basic assumption may not be followed when an entity in bankruptcy reports financial results?

a. Economic (Accounting) entity assumption

b. Going concern assumption
c. Time period assumption
d. Monetary unit assumption

3. Which underlying assumption serves as the basis for preparing financial statements at regular
arbitrary or artificial points in time?

a. Accounting entity
b. Going concern
c. Accounting period
d. Stable monetary unit

4. Which is not an important characteristic of the financial statements that accountants currently
prepare?

a. The information in financial statements is expressed in units of money adjusted for changing
purchasing power
b. Financial statements articulate with one another because measuring financial position is
related to measuring changes in financial position
c. The information in financial statements is summarized and classified to help meet users’
needs
d. Financial statements can be justified only if the benefits exceed the costs.

5. The concept of accounting entity is applicable

a. Only to the legal aspects of business organizations
b. Only to the economic aspects of business organizations
c. Only to business organizations
d. Whenever accounting is involved