Chapter 5: Elements of Financial Statements

TECHNICAL KNOWLEDGE
To identify the elements directly related to the measurement of financial position
and financial performance.
To understand the concept of asset, liability and equity.
To understand the concept of income and expenses.

Elements of Financial Statements

-refer to the quantitative information reported in the statement of financial
position and income statement
-are the building blocks “from which financial statements are constructed.”
-the presentation of these elements in the statement of financial position and
the income statement involves a process of classification and sub-classification.
For example, asset and liabilities may be classified by their nature or function
in the business of the entity in order to display information in a manner most
useful to users for purposes of making economic decisions.

The elements directly related to the measurement of financial position are:

a. Asset
b. Liability
c. Equity

The elements directly related to the measurement of financial performance are:

a. Income
b. Expense

The Conceptual Framework identifies no element that are unique to the

statement of changes in equity because such statement comprises items that
appear in the statement of financial position and the income statement
 Equity is the residual interest in the assets of the entity after deducting all the
liabilities.
Asset
Under the Revised Conceptual Framework, an asset is defined as a present
economic resources controlled by the entity as the result of post events
. The new definition clarifies that an asset is an economic resource and that
the potential economic benefits no longer need to be expected to flow to the
entity.
Essential characteristics of asset
a. The asset is a present economic resource.
b. The economic resource is a right that has the potential to produce economic
benefits.
c. The economic resource is controlled by the entity as the result of past
events.
Right
Rights that have the potential to produce economic benefits may take the
following forms:
1. Rights that correspond to an obligation of another entity
a. Right to receive cash
b. Right to receive goods or services
c. Right to exchange economic resources with another party on favorable
terms
d. Right that do not correspond to an obligation of another party if a
specified uncertain future event occurs
2. Rights that do not correspond to an obligation of another entity
a. Right over physical objects, such as property, plant and equipment or
inventories
b. Right to intellectual property
3. Rights established by contract or legislation, such as owning a debt
instrument or an equity instrument or owning a registered patent.
Potential to produce economic benefits
An economic resource is a right that has the potential to produce economic
benefits.
For the potential to exist, it does need to be certain or even likely that the right
will produce economic benefits.
It is only necessary that the right already exists.
A right can meet the definition of an economic resource even if the probability
that it will produce economic benefit is low.
The economic resource is the present right that contains the potential and not the
future economic benefits that the right may produce.
An economic resource could produce economic benefits if an entity is entitled:
a. To receive contractual cash flows
b. To exchange economic resources with another party on favorable terms
c. To produce cash inflows or avoid cash outflows
d. To receive cash by selling the economic resource
e. To extinguish a liability by transferring an economic resource
Control of an economic resource
An entity controls an asset if it has the present ability to direct the use of the
asset and obtain the economic benefits that flow from it.
Control also includes the ability to prevent other from using such asset and
therefore preventing others from obtaining the economic benefits from the asset.
Control may arise if an entity enforces legal rights.
If there no legal rights, control can still exist if an entity has other means of
ensuring that no other party can benefit from an asset.
For example, an entity has the access to technical know-how and has the ability
to keep this know-how secret.
LIABILITY
Under the Revised Conceptual Framework, a liability is defined as the present
obligation of an entity to transfer an economic resource as a result of past events.
The new definition clarifies that a liability is the obligation to transfer an
economic resources and not the ultimate outflow of economic benefits.
The outflow of economic benefits no longer needs to be expected similar to the
definition of an asset.
The new definition of liability to some extent is inconsistent with the definition of
liability under IAS. In case of conflict, the IASB stated that requirements of a
Standard shall always prevail over the Conceptual Framework
Essential characteristics of liability
a. The entity has an obligation.
The entity liable must be identified. It is not necessary that the payee or
the entity to who the obligation is owed be identified.
 b. The obligation is to transfer an economic resources
c. The obligation is a present obligation that exists as a result of past event
This means that a liability is not recognized until it is incurred.
Obligation
An obligation is a duty or responsibility that an entity has no longer practical
ability to avoid. Obligations can either be legal or constructive.
Obligation may be legally enforceable as a consequence of a binding contract or
statutory requirement.
This is normally the case, for example, with accounts payable for goods and
services received.
Constructive obligation arise from normal business practice, custom and a desire
to maintain good business relations or act in an equitable manner.
For example, an entity decides as a matter of policy to rectify faults in the faults
in the products even when these become apparent after the warranty period.
Transfer of an economic resource
Obligations to transfer an economic resource include:
a. Obligation to pay cash
b. Obligation to deliver goods or noncash resources
c. Obligation to provide services at some future time
d. Obligation to exchange economic resource with another party on
unfavorable terms
e. Obligation to transfer an economic resource if specified uncertain future
event occurs
Past event
An obligation exist as a result of past event if both the following conditions are
satisfied:
a. An entity has already obtained economic benefits.
b. An entity must transfer an economic resource
Definition of income
Income is defined as increases in assets or decreases in liabilities that result in
increase in equity, other than those relating to contributions from equity holders.
Revenue, arises in the course of the ordinary regular activities and is referred to
by variety of different names including sales, fee, interest, dividends, royalties
and rent.
The essence of revenue is regularity.
Gains represent other items that meet the definition of income and do not arise in
the course of the ordinary regular activities.
Gains include gain from disposal of non-current asset, unrealized gain on trading
investment and gain form expropriation.
Statement of financial performances
The Revised Conceptual Framework introduces the term statement of financial
performance.
This statement refers to the statement of profit or loss and statement presenting
other comprehensive income.
The statement of profit or loss is the primary source of information about an
entity’s financial performance. As a general rule, all income and expenses are
included in profit or loss.
Definition of expense
Expense is defined as decreases in assets or increases in the liabilities that
result in decreases in equity, other than those relating to distributions to equity
holders.
The definition of expense has changed to reflect the change in the definition of
asset and liability.
Expenses encompass losses as well as those expenses that arise in the course of
the ordinary regular activities.
Expenses that arise in the course of ordinary regular activities include cost of
goods sold, wages and depreciation.
Losses do not arise in the course of the ordinary regular activities and include
losses resulting from disaster.
Examples include losses from fire, flood, storm surge, tsunami and hurricane as
well as those arising from disposal of non-current assets.
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