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The elements of financial position describe amounts of resources and claims against resources at the moment in time.
Asset- it is a resource controlled by the entity as a result of past event and from which future economic benefits are
expected to flow to the entity.
Liability- it is a present obligation of an entity arising from past event the settlement of which is expected to result in an
outflow from the entity of resources embodying economic benefits.
Equity- It is a residual interest in the assets of the entity after deducting all of the liabilities.
Income
It is an increase in economic benefit during the accounting period related to an increase in asset or a decrease in
liability that results in increase in equity other than contribution from owners.
Encompasses both revenue and gain.
Expense- It is a decrease in economic benefit during the accounting period related to an decrease in asset or a increase in
liability that results in decrease in equity other than contribution from owners.
Revenue- This arises in the course of ordinary regular activities and is referred to by a variety of different names including
sales, fees, interest, dividends, royalties and rent.
Expense recognition
Basic expense recognition means that expense are recognized when incurred
Application of the matching principle
There is no gain if there is no pain
Matching principle has three applications:
o Cause and effect association
o Systematic and rational allocation
o Immediate recognition
Immediate recognition
Cost incurred is expense outright
An expense is recognized immediately:
o When an expenditure produces no future economic benefit
o When cost incurred does not qualify or ceases to qualify for recognition as an asset.
o Example: Officers’ salaries and most administrative expense, advertising and most selling
expenses, amount to settle lawsuit and worthless intangibles.
Derecognition defined as the removal of all or part of a recognized asset or liability from the statement of
financial position.
Measurement is defined as quantifying in monetary terms the elements in the financial statements.
Two categories:
1. Historical cost
Historical of an asset is the cost incurred in acquiring or creating the asset compromising the
consideration paid plus transaction cost
Historical of an liability is the consideration received to incur the liability minus transaction cost
Historical cost is the entry price or entry value to acquire an asset or to incur a liability.
2. Current cost
Fair value
o Asset: price that would be received to sell an asset in an orderly transaction between
market participants at measurement date.
o Liability: price that would be paid to transfer a liability in an orderly transaction between
market participants at measurement date.
o Not adjusted for transaction cost
Value in use for asset
o Present value of the cash flows that an entity expects to derive from the use of an asset and
from the ultimate disposal
Matching of cost with revenue- It is the process that involves the simultaneous or combined recognition of
revenue and expenses that result directly from the same transactions and other events.
When economic benefits are expected to arise over several accounting periods and the association with income
can only be broadly or indirectly determined, expenses are recognized on the basis of systematic and rational
allocation.
An expense is recognized immediately when an expenditure produces no future economic benefit and when
cost incurred ceases to quality as an asset.
Measurement- It is the process of determining the monetary amounts at which the elements of the financial
statements are recognized and carried in the financial statements.
Primary measurement basis is the market price at the date the asset was acquired.
Recognition of revenue:
Revenue from rendering of services shall be recognized by reference to the stage of completion of the
transaction.
Royalty revenue shall be recognized on an accrual basis
Dividend revenue shall be recognized when the shareholder’s right to receive payment is established.
For transactions involving the rendering of services:
o The amount of revenue and the costs incurred and costs to complete can be measured reliably.
o It is probable that payment for the services shall be received by the entity.
o The stage of completion of the transaction at the end of reporting period can be measured reliably.
Income recognized using the installment method of accounting generally equals cash collected multiplied by
gross profit percentage.
Under the installment method of accounting, gross profit on an installment sale is recognized in income in
proportion to the cash collection.
Under the cost recovery method of accounting, gross profit on an installment sale is recognized after cash
collections equal to the cost of sales have been received.
An entity is engaged in extensive exploration for water. If upon discovery of water, the entity need not recognize
any revenue from water sales unit the sales exceed the cost of exploration, the basis of revenue recognition being
employed is sunk cost or cost of recovery basis.
There is no reasonable basis for the estimating collectability, the use of the cost recovery method of revenue
recognition to account for installment basis.
The installment method of recognizing revenue should be used when no reasonable basis exists for estimating
the collectability.
Installment sales method appropriate for the recognition of revenue, when for sales where collection is
spread over a reasonable long period of time and significant doubt exists about ultimate collection of installments
receivable.
When using the installment method of revenue recognition, total revenue and costs are recognized at the point
of sale but gross profit is deferred in proportion to the cash that is uncollected from the sale.
The cost of recovery method of revenue recognition is used only when circumstances surrounding a sale are
so uncertain that earlier recognition is impossible.
Revenue recognition reflects the greatest degree of uncertainty about future events, when cost recovery method
applied to installment sales
The term “revenue recognition” conventionally refers to the process of identifying transactions to be recorded
as revenue in an accounting period.
When the ultimate sale of the goods is at an assured sales price, it is proper to recognize revenue prior to the
sale of the merchandise.
Realization- means the process of converting noncash resources and rights into cash or claims to cash.
Equipment was sold in exchange for a note receivable conforms to the realization concept.
Revenue may result from a decrease in a liability from primary operations.
Installment method of revenue recognition when there is no reasonable basis for estimating collectability.
The installment method of accounting may be used if the ultimate amount collectible is inappropriate.
Costs that can be reasonably associated with specific revenue but not with specific products should be
expensed in the period in which the related revenue is recognized.
Certain costs of doing business capitalized when incurred and then depreciated or amortized over subsequent
accounting periods to match the costs of production with revenue as earned.
Sales commission-example of the expense recognition principle of associating cause and effect.
Aggregation is the adding together of assets, liabilities, equity, income and expenses that have similar or shared
characteristics and are included in the same classification.
Two approaches:
Transaction approach- is the traditional preparation of an income statement
Capital approach- means that net income occurs only after the capital used from the beginning of the
period is maintained.
Physical Capital
o Quantitative measure of the physical productive capacity to produce goods and services
o Requires that productive assets be measured at current cost, rather than historical cost.
Under this concept, net income occurs “when the physical productive capital of the entity at the end of the
year exceeds the physical productive capital at the beginning of the period, also after excluding distributions
to and contributions from owners during the period.”