Chapter-5 - Lecture notes 5 PDF

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ELEMENTS OF FINANCIAL STATEMENTSFinancial 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...

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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 defined as a 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. b. c. d.

Right to receive cash Right to receive goods or services Right to exchange economic resources with another party on favorable terms 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. b. c. d. e.

To receive contractual cash flows To exchange economic resources with another party on favorable terms To produce cash inflows or avoid cash outflows To receive cash by selling the economic resource 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. Obligation. 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. b. c. d. e.

Obligation to pay cash Obligation to deliver goods or noncash resources time Obligation to provide services at some future Obligation to exchange economic resources party on unfavorable terms with another 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 trading 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 a 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 surge, tsunami and hurricane, as well as those arising from disposal of noncurrent assets.

Problem 5-1 Multiple choice (ACP)

1. The elements directly related to the measurement of financial position are a. Asset, liability and equity b. Asset and liability c. Income and expense d. Asset, liability, equity, income and expense 2. The elements of financial position describe amounts resources and claims against resources a. During a period of time b. At a moment in time c. During a period of time and at a moment in time d. Neither during a period of time or at a moment in time 3. The elements directly related to the measurement of financial performance are a. b. c. d.

Income and expense Asset, liability and equity Asset and liability income, expense and equity

4. It is a present economic resource controlled by the entity as a result of past events. a. Asset b. Liability c. Equity d. Income 5. It is a present obligation of the entity to transfer an economic resource as a result of past events. a. b. c. d.

Asset Liability Equity Expense...