CHAPTER 5 CONCEPTUAL FRAMEWORK – 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 of financial
position and the income statement involves a process of classifications and subclassifications.

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 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) Right to receive cash
b) Right to receive goods or services
CHAPTER 5 CONCEPTUAL FRAMEWORK – ELEMENTS OF FINANCIAL STATEMENTS
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
2. Right 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. Right 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 assets 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.
CHAPTER 5 CONCEPTUAL FRAMEWORK – ELEMENTS OF FINANCIAL STATEMENTS
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 if policy to rectify faults in the products even when these become
apparent after the warranty period.

Transfer of an economic resource

Obligation 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.
CHAPTER 5 CONCEPTUAL FRAMEWORK – ELEMENTS OF FINANCIAL STATEMENTS

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 terms statements of financial performance.

This statement refers to the statement of profit and 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.