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Chapter 5 Elements of Financial Statements

The document defines and describes the key elements of financial statements. It explains that the elements are assets, liabilities, equity, income and expenses. Assets are defined as resources controlled by an entity from past events that have potential future economic benefits. Liabilities are defined as obligations to transfer economic resources that result from past events. Income increases assets or decreases liabilities, increasing equity. Expenses decrease assets or increase liabilities, decreasing equity. The elements are the building blocks used to construct the statement of financial position and statement of financial performance.

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298 views

Chapter 5 Elements of Financial Statements

The document defines and describes the key elements of financial statements. It explains that the elements are assets, liabilities, equity, income and expenses. Assets are defined as resources controlled by an entity from past events that have potential future economic benefits. Liabilities are defined as obligations to transfer economic resources that result from past events. Income increases assets or decreases liabilities, increasing equity. Expenses decrease assets or increase liabilities, decreasing equity. The elements are the building blocks used to construct the statement of financial position and statement of financial performance.

Uploaded by

MicsjadeCastillo
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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ELEMENTS OF FINANCIAL STATEMENTS

Financial statements portray the financial effects of transactions and other events by
grouping them into broad classes according to their economic characteristics.

These broad classes are termed the elements of financial statements.

The elements of financial statements refer to the quantitative information reported in


the statement of financial position and income statement.

The elements of financial statements 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 subclassification.

For example, assets 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 elements 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 of the
liabilities.

ASSET
Under the Revised Conceptual Framework, an asset is defined as o present economic
resource controlled by the entity as a result of past events.

An economic resource is a right that has the potential to produce economic benefits.
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 a 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 to benefit from 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 not 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 others 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 are 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 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 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
resource 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 37.
In case of conflict, the IASB stated that the 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
whom the obligation is owed be identified.
b. The obligation is to transfer an economic resource.
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 practical ability to avoid.
Obligations can either be legal or constructive.
Obligations 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 obligations 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 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 resources with another party on unfavorable terms
e. Obligation to transfer an economic resource if specified uncertain future event occurs

Past event
An obligation exists as a result of past event if both of 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 increases


in equity, other than those relating to contributions from equity holders.

The definition of income has changed to reflect the change in the definition of asset and
liability.

The definition of income encompasses both revenue and gains.


Revenue arises in the course of the ordinary regular activities and is referred to by
variety of different names including sales, fees, 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 noncurrent asset, unrealized gain on investment and
gain from expropriation.

Statement of financial performance


The Revised Conceptual Framework introduces the term statement of financial
performance.
This statement refers to the statement of profit or loss and a statement presenting
other comprehensive income.
The statement of profit or loss is the primary source of information about an entity's
financial performance. As general rule, all income and expenses are included in profit or
loss.

However, in developing accounting standards, there are Some items of income and
expenses that are included in other comprehensive income and not in profit or loss if such
presentation would provide more relevant and faithfully represented information about
financial performance.
There are instances that an amount in other comprehensive income in one reporting
period may be recycled to profit or loss in another reporting period.
Such recycling is permitted as long as it would result to relevant and faithfully
represented information about financial performance.
Definition of expense
Expense is defined as decreases in assets or increases in 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 disasters.

Examples include losses from fire, flood, storm from surge, disposal tsunami and
hurricane, as well as those arising noncurrent assets.

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