Chapter 5: ELEMENTS OF FINANCIAL STATEMENTS
benefits:
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
Rights that have the potential to produce economic
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.
Chapter 6: RERCOGNITION AND MEASUREMENT
RECOGNITION
• As the process of capturing for inclusion in the
financial statements an item that meets the
DEFINITION of an ASSET, LIABILITY, EQUITY,
INCOME OR EXPENSE.
• The amount at which an asset, a liability or equity
is recognized in the statement of financial
position is reported as carrying amount.
• Recognition links the elements to the financial
statement of financial position and statement of
financial performance.
• For example, the recognition of income happens
simultaneously with the recognition of an
increase in asset and decrease in liability.
Recognition Criteria:
➢ Only items that meet the definition of an
asset, liability or equity are recognized in the
statement of financial position.
➢ Only items that meet the definition of an
income or expense are recognized in the
statement of financial performance.
➢ Items are recognized only when their
recognition provides users of FS with
information that is both relevant and
faithfully represented.
➢ Recognition does not focus anymore on
how probable economic benefits will flow to
or from the entity and that the cost can be
measured reliably.
➢ An asset or liability and any corresponding
income or expense can exist even if the
probability of inflow or outflow of the
benefits is low.
INCOME RECOGNITION
Basic Principle: INCOME shall be recognized when
EARNED.
When is Income Considered to be Earned?
• In the sale of goods in the ordinary course of
business, the point of sale is the point of income
recognition.
• Stated differently, legal title to the goods passes
to the buyer at the point of sale.
• However, in certain condition, income may be
recognized at the point of production, during
production and at the point of collection.
EXPENSE RECOGNITION
Expense Recognition Principle:
EXPENSES are recognized when incurred.
When are Expenses Incurred?
• MATCHING PRINCIPLE – generation of revenue is
not without any cost. There has got to be some
cost in earning a revenue. It requires that those
costs and expense incurred in earning a revenue
shall be reported in the same period.
Matching Principle Application:
1. Cause and Effect Association
- expense is recognized when the
revenue is already recognized.
- The reason is presumed direct
association of the expense with
specific income.
- Strict Matching Principle
2. Systematic and Rational Allocation
- some costs are expensed by simply
allocating them over the periods
benefited.
- The reason for this principle is that the
cost incurred will benefit future
periods and that there is an absence of
a direct or clear association of the
expense with specific revenue.
- 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 allocation procedures.
3. Immediate Recognition
- the cost incurred is expensed
OUTRIGHT because of uncertainty of
future economic benefits or difficulty
of reliably associating certain costs
with future revenue.
- An expense is recognized 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.