Chapter 5: ELEMENTS OF FINANCIAL STATEMENTS
Rights that have the potential to produce economic
FINANCIAL STATEMENTS - portray the financial effects of
transactions and other events by grouping them into
broad classes according to their economic characteristics.
ELEMENTS OF FINANCIAL STATEMENTS
 The broad classes
 Quantitative information reported in the
statement of financial position and income
statement.
 Building blocks from which FS are constructed.
Financial Position
a. Asset
b. Liability
c. Equity
Assets – Liabilities = Equity
Financial Performance
a. Income
b. Expense
Income – Expenses = Profit
Recognition – the process of incorporating an item that
meets the definition of an element and satisfies the
recognition criteria, into the statement of financial
position or statement of profit or loss and other
comprehensive income.
ASSETS
 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.
 Thus, it is that the potential economic benefits no
longer need to be expected to flow to the entity.
Essential Characteristics of an 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
Asset Measurement
 Cash transaction – Cash payment
 Noncash or exchange transaction
o Fair value of the asset given
o Fair value of the asset received
o Carrying amount of the asset given
benefits:
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
a. Owning a debt instrument or an equity
instrument or owning a registered patent.
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.
- 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 flow
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 is the ability to prevent others from
using such asset and therefore preventing
others from obtaining the economic benefits
from the assets. Thus, it may arise if an entity
enforces legal rights.
LIABILITY
 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 economic resource and not
the ultimate outflow of economic benefits.
Essential Characteristics of a Liability
- The entity has an obligation
- The entity liable must be identified.
However, it is not necessary that the
payee or the entity to whom the
obligation is owed be identified.
- The obligation if to transfer an economic
resource
- The obligation is a present obligation that exists
as a result of past events
- Means that liability is not recognized
unless incurred.
Obligation – is a duty or responsibility that an entity has
no practical ability to avoid. Obligations can either be
legal or constructive.
a. Legal Obligation – obligations may be legally
enforceable as a consequence of a binding
contract or statutory requirement.
b. Constructive Obligations – arise from normal
business practice, custom and desire to
maintain good business relations or act in an
equitable manner.
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
EQUITY
 residual interest in the assets of the entity after
deducting all liabilities.
INCOME
 Increases in assets or decreases in liabilities that
result in increases in equity, OTHER THAN those
relating to contributions from equity holders.
 Income is increases in economic benefits during
the accounting period in the form of inflows or
enhancements of assets or decreases of liabilities
that result in increases in equity, other than those
relating to contributions from equity participants.
 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 exportation.
Point of Sale – Recognition of Income
STATEMENT OF FINANCIAL PERFORMANCE
 Refers to the income statement and a statement
presenting other comprehensive income.
Income Statement / 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 provide more relevant and
faithfully represented information about
financial information.
EXPENSE
 Decreases in assets or increases in liabilities that
result in decreases in equity, OTHER THAN those
relating to distributions to equity holders.
 Decreases in economic benefits during the
accounting period in the form of outflows or
depletions of assets or incurrences of liabilities
that result in decreases in equity, other than those
relating to distributions to equity participants.

The definition of expense has changed to reflect the

change in the definition of asset and liability.
 Expenses encompasses losses as well as
those expenses that arise in the course of
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 ordinary
regular activities and include losses
resulting from disasters.

Expense Recognition Principle

1. Direct association or matching
2. Systematic and rational allocation
3. Immediate recognition

Measurement – the process of determining the

monetary amounts at which the elements of the
financial statements are to be recognized and
carried in the statement of financial position and
statement of comprehensive income.
  However, in certain condition, income may be
recognized at the point of production, during
production and at the point of collection.

Chapter 6: RERCOGNITION AND MEASUREMENT

EXPENSE RECOGNITION
RECOGNITION
Expense Recognition Principle:
 As the process of capturing for inclusion in the
EXPENSES are recognized when incurred.
financial statements an item that meets the
DEFINITION of an ASSET, LIABILITY, EQUITY,
When are Expenses Incurred?
INCOME OR EXPENSE.
 MATCHING PRINCIPLE – generation of revenue
 The amount at which an asset, a liability or
is not without any cost. There has got to be
equity is recognized in the statement of financial
some cost in earning a revenue. It requires that
position is reported as carrying amount.
those costs and expense incurred in earning a
 Recognition links the elements to the financial
revenue shall be reported in the same period.
statement of financial position and statement of
financial performance.
Matching Principle Application:
 For example, the recognition of income happens
simultaneously with the recognition of an
1. Cause and Effect Association
increase in asset and decrease in liability.
- expense is recognized when the
revenue is already recognized.
Recognition Criteria:
- The reason is presumed direct
 Only items that meet the definition of an
association of the expense with
asset, liability or equity are recognized in
specific income.
the statement of financial position.
- Strict Matching Principle
 Only items that meet the definition of an
income or expense are recognized in the
2. Systematic and Rational Allocation
statement of financial performance.
- some costs are expensed by simply
 Items are recognized only when their
allocating them over the periods
recognition provides users of FS with
benefited.
information that is both relevant and
- The reason for this principle is that the
faithfully represented.
cost incurred will benefit future
 Recognition does not focus anymore on
periods and that there is an absence
how probable economic benefits will flow
of a direct or clear association of the
to or from the entity and that the cost can
expense with specific revenue.
be measured reliably.
- When economic benefits are
 An asset or liability and any corresponding
expected to arise over several
income or expense can exist even if the
accounting periods and the
probability of inflow or outflow of the
association with income can only be
benefits is low.
broadly or indirectly determined,
expenses are recognized on the basis
INCOME RECOGNITION
of systematic and allocation
procedures.
Basic Principle: INCOME shall be recognized when
EARNED.
3. Immediate Recognition
- the cost incurred is expensed
When is Income Considered to be Earned?
OUTRIGHT because of uncertainty of
 In the sale of goods in the ordinary course of
future economic benefits or difficulty
business, the point of sale is the point of
of reliably associating certain costs
income recognition.
with future revenue.
 Stated differently, legal title to the goods passes - An expense is recognized
to the buyer at the point of sale. immediately:
 a. When an expenditure
produces no future
economic benefit.
b. When cost incurred does
not qualify or ceases to
qualify for recognition as
an asset.
DERECOGNITION
 The removal of all or part of a recognized asset
or liability from the statement of financial
position.
 It occurs normally when an item no longer
meets the definition of an asset or a liability.
Derecognition of an Asset – entity loses
control of all or part of the asset
Derecognition of a Liability – entity no
longer has a present obligation for all or
part of the liability.
MEASUREMENT
- Defined as quantifying in monetary terms the
elements in the financial statements.
Categories:
1. HISTORICAL COST
- Historical cost of an asset or original
acquisition cost of an asset is the cost
incurred in acquiring or creating the asset
comprising the consideration paid plus
transaction cost.
- Historical cost of a liability is the
consideration received to incur the liability
minus transaction costs.
- Historical cost is the entry price or entry
value to acquire an asset or to incur a
liability.
- An application of the historical cost
measurement is to measure financial asset
and financial liability at amortized cost.
- Amortized cost reflects the estimate of
future cash flows discounted at a rate
determined at initial recognition.
Historical Cost Updated
1. Historical cost of an asset is updated
because of
a. Depreciation and amortization
b. Payment received as a result of
disposing part or all of the asset
c. Impairment
d. Accrual of interest to reflect any
financing component of the asset
e. Amortized cost measurement of
financial asset
2. Historical cost of a liability is updated
because of
a. Payment made or satisfying an
obligation to deliver goods
b. Increase in value of the obligation
to transfer economic resources
such that the liability becomes
onerous
c. Accrual of interest to reflect any
financing component of the
liability
d. Amortized cost measurement of
financial liability
2. CURRENT VALUE
a) Fair Value
- Fair value of an asset is the price
that would be received to sell an
asset in an orderly transaction
between market participants at
measurement date.
- Fair value of liability is the price that
would paid to transfer a liability in an
orderly transaction between market
participants at the measurement
date
- Fair value is an exit price or exit
value.
- Fair value can be observed directly
using market price of the asset or
liability in an active market. In cases
where fair value cannot be directly
measured, an entity can use present
value of cash flows.
- Fair value is not adjusted for
transaction cost. The reason is that
such cost is a characteristic of the
transaction and not of the asset or
liability.
b) Value in Use for Asset
- The present value of the cash flows
that an entity expects to derive from
the use of an asset and from the
ultimate disposal.
- Does not include transaction cost on
acquiring the asset but includes
 transaction cost on the disposal of
the asset.
- Value in use is an exit price or exit
value.
c) Fulfillment for Liability
- Present value of cash that an entity
expects to transfer in paying or
settling a liability.
- Fulfillment value is the present value
of cash that an entity expects to
transfer in paying or settling a
liability.
- Fulfillment value does not include
transaction cost on incurring a
liability but includes transaction cost
on fulfillment of a liability.
- Fulfillment value is an exit price or
exit value.
d) Current Cost
- Current cost of an asset is the cost of
an equivalent asset at the
measurement date comprising the
consideration paid and transaction
cost.
- Current cost of a liability is the
consideration that would be received
less any transaction cost at
measurement date.
- Similar to historical cost, current cost
is also based on the entry price or
entry value but reflects market
conditions on measurement date.
Selecting a Measurement Basis
 In selecting a measurement basis for an asset or a
liability and for the related income and expense, it is
necessary to consider the nature of the information
that the measurement basis will produce.
 In most cases, no single factor will determine which
measurement basis should be selected.
 The relative importance of each factor will depend
on facts and circumstances.
 The information produced by the measurement
basis must be useful to the users of financial
statements.
 To achieve this, the information must be both
relevant and faithfully represented.
 Historical cost is the measurement basis most
commonly adopted in preparing financial
statements. In many situations, it is simpler and less
costly to measure historical cost than it is to
measure a current value.
 In addition, historical cost is generally well
understood and verifiable.
 The IASB did not mandate a single measurement
basis because the different measurement bases
could produce useful information under different
circumstances.
BASIC PRINCIPLES
Objectivity Principle
 States that all business transactions that will be
entered in the accounting records must be duly
supported by verifiable evidence.
Historical Cost
 Means that all properties and services acquired
by the business must be recorded at its original
acquisition cost.
Revenue Recognition Principle
 States that income is recognized in the
accounting period when the goods are delivered
or services are performed.
Expense Recognition Principle
 Expenses should be recognized in the
accounting period in which goods and services
are used up to produce revenue and not when
the entity pays for those goods and services.
Adequate Disclosure
 Requires that all relevant information that
would affect the user’s understanding and
assessment of the accounting entity be
disclosed in the FS.
Consistency Principle
 Use the same accounting method from period to
period to achieve comparability over time within
a single enterprise.
Accrual Basis
 The effects of transactions and other events are
recognized when they occur and not as cash or
its equivalent is received or paid. This means
that the accountant records revenues as they
are earned and expenses as they are incurred.