CHAPTER 5 CONCEPTUAL FRAMEWORK Elements of financial statements TECHNICAL KNOWLEDGE To identify the elements directly related to the measurement of financial position and financial performance. To understand the concept of asset, liability and equity. expenses.cIAL STATEMENTS ELEMENTS OF FINAN' cial statements portray the Ace adh effects q ction: other events by grouping them m in : ‘according to their economic ¢| teristics, road | These broad classes are termed the elements of Financiag statements. : ca financial statements refer to the quantitayiy, aprameaa reid in the statement of financial Position ant 4 income statement. é The elements of financial statements a fale blocks from which financial statements are ments in the-statement of The presentation of these ele! 1 “ e income statement involves g financial position and th states 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 tp 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 unique to the statement of changes in ¢ , statement comprises ite ‘that ap inASSET . Under the Revised Conceptual Framework, an asset is defined as a present economic resource controlled by the entity asa 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 Right to receive cash . Right to receive goods or services Right to exchange economic resources with another . Rit on tent em terms ligation of 't to benefit from an o! ition another party if a specified unce: oop a rtain future event occurs mint Rights tha do not correspond to an obligationPotential to produce economic benefits cf resource is o right that has the potential to need to be certain or economic benefits. An economic res produce economic ii i it the potential to exist, it does no coe likely that the right will produce It is only necessary that the right already exists. iti ic resource even A right can meet the definition of an economic re' € if the probability that it will produce economic benefit is low. i i i tains the Thi ¢ resource is the present right that con’ R Somatal 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 _ To exchange economi¢ resourees with another party on b. 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 also includes the ability to prevent oth using ers: such asset and therefore preventing others Hs cae the economic benefits from the asset. a Control may arise i; ility e ae ta ere are no le hts, control ill exi ate Pa has other ae ' rata from an asset, For example, an entit has the ability is ieLIABILITY Under the Revised Conceptual Framework, a liability is define 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. However, 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 proctical ability to avoid. Obligations can either be legal, or constructive. : may be legally enforceable as a consequence of a ding contract or statutory requirement. This is analy the sa Be sscbt with secounte payableTransfer of an economic resource Obligations to transfer an economic resource include: bligation to pay cash S Opliearia y liver goods or noncash resources b. Obligation to de “ c Ohtication to provide services at some future time d. Obligation to exchange economic resources with another arty on unfavorable terms | Bbligation to transfer an economic ‘resource if specified e. 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 i uit ged to reflect the change the definition of asset and liability. ‘i Income encompasses both revenue and gains, Revenue arises in the course of the ordin: a: and is referred to by variety of different naneo eni fees, interest, dividends, aStatement of financial performance The Revised Conceptual Framework introduces the term statement of financial performance. e statenient of financial performance refers to the incon remitbk and a statement presenting other comprehensive income. The income statement or statement of profit or loss is the primary source of information about an éntity's financial formance. 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. z aa Bp Expenses encompass losses a8 well as those expen 6 ®nse in the course of the ordinary regular activities. Expenses that arise in the course of ordinary. activities include cost of goods sold, Losses do not aise i 601 activities and ischute laaQUESTIONS i statements. 1. Define elements of financial ts directly related to the re the elements ©) pbabncenent of financial positio ae hs - 3. What are the elements directly rele e a “ measurement’ of financial performance: 4. Define an asset. inti 2 5. What are the essential characteristics of an asset? 6. Explain a right to produce economic. benefit. 7. Explain control of an economic resource. 8. Define a liability. 9. What are the essential chataicteristiva ofa liability? 10. Explain an obligation, 11. Explain legal obligation and constructive obligation. 12. Define income. 15. Distinguish income from revenue, 14. Define an expense, 15. Distinguish: expenses from loss,PROBLEMS i Problem 5-1 Multiple choice (ACP) 1. The elements directly related to the measurement of finaxicial position are a. Asset, liabilit; Yaiee and equity iM Asset and liabili c. Income and eapaihe d. Asset, liability, equity, income and expense 2. The elements of financial position describe amounts of resources and claims against resources a. During a period of time b. At a moment in time Si During a period of time and at a moment in time . Neither during a period of time nor at a moment in time 3. The elements directly related to the measurement of financial performance are a. Income and expense b. Asset, liability and equity c. Asset and liability 4d. Income, expense and equity 4. It is a present economic resource controlled by Eoesentity as a result apne events. a feet ¢ Equi6. It is the residual interest in the assets of the entity iafter deducting all of the liabilities. a. Income b. Equity i . c. Retained earnings up d. All of the choices match the definition : 7.It is an increase in asset or a decrease in liability that results in increase in equity other than contribution from equity holders. a. Asset b. Liability c. Income d. Expenses 8. It is a decrease in asset or an increase in liability that results in decrease in’ equity other than distribution to equity holders. Asset, Liability Income Expense 9, This arises in the course of ordinary re; activitiseteeaanl the entity and is referred to by a. mi do vities of | including ele, foo, interest, dividends, ryaltcs and rent, a. Income a b. Revenue 5 ‘a F ¢. Profit d: Gain 10. Which tai a. Income b. Revenue ¢. Gain e: d. Income Be opProblem 5-2 Multiple choice (Conceptual Framework) 1. Which is not within the new definition of an asset? tis a it economic resource. , b The exonom renuree i a right that has potential to roduce economic benefit. 4 © economic resourve is controlled by the entity as a result of past event. , ad Futire economic benefit is expected to flow to the entity. 2. Which of the following criteria need not be satisfied for a liability to exist? a. The entity has an.obligation. r b. The obligation is to transfer an economic resource. c. The obligation is.a present obligation that exists as a result of a past event. d. The settlement is expected to result in an outflow of economic benefit. # A present obligation exists as result of past event if a. The entity has already obtained economic benefit. b. The entity must transfer an economic resource. c. The entity has not yet obtairied economic benefit but must transfer an' economic resource. d. The entity has already obtained economic benefit and must transfer economic resource. 4 Rights that have the potential to produce economic benefits and correspond to an obligation of another entity include except 4 a. Right to receive cash ‘ b. Right to receive goods Satie c. Right to exchange economic resources with, ano’ entity on favorable terms». | ; Right over property, plant and equipment 5. An economic resource could produce economic entity is entitled to all, except 5 “ To receive contractual To exchange economic on unfavorable terms To receive cash by 1 . To extinguish a lia resource oP a9is ability to direct the use of an economic * pote tnd ebtala the benefit that may flow from it. a. Control b. Legal right c. Obligation d. Ownership 7. It is a duty or responsibility that an entity has no, practical ability to avoid. Right Obligation Equity Expense BP op 8. Obligations to transfer an economic resource include all, except Obligation to pay cash Obligation to deliver goods Obligation to provide services - Obligation to transfer an economic resource even ifa specified future event does not occur orp © Which statement is not true about income and expense? a. Income is increase in asset or decrease in liability that results in increase in equity other than contribution from 4 equity holders, . Expense is decrease in asset or increase in liability that results in decrease in équity other than tistanete to equity holders. ¢. Income and epecace are the elements that relate to position. ‘ d. Income encompasses revenue and gain, 10. This new term refers to the incom | statement presenting other comprehensive eee i.Problem 5-3 Multiple choice (AICPA Adapted) 1. Revenue may result from A decrease in an asset from primary operations. An increase in'an asset from incidental transactions. An increase in a liability from incidental transactions. A decrease in a liability from primary operations: mo > s 2. What is the primary distinction between revenue and gain? The materiality of the amount The likelihood that the transaction’ will recur The nature of the activity that gives rise to the transaction d. The method of disclosing the transaction 2 op 3. The term income a. Includes revaluation of land. b. Includes adjustment of prior period error. c. Includes gain resulting from the sale of an asset in an arm’s length transaction. d. Is the same as retained earnings. 4. A decrease in an asset arising from peripheral or incidental transaction is called - a. Capital expenditure b. Cost : c. Loss d. Expense 5. An outflow of asset based the major operations is a. Loss b. . Liability c. Expense d. Equity