Gripping GAAP The conceptual framework for financial reporting Gripping GAAP The conceptual framework for financial

AP The conceptual framework for financial reporting

1. Introduction (CF: SP1.1-1.5)

Contents continued … Page
1.1 General overview Status of the CF:
5. Elements 50 x not an IFRS!
The Conceptual Framework for Financial Reporting (CF) x forms the basis of IFRSs.
5.1. Overview 50 x may not override an IFRS.
5.2. Asset definition 51 is technically not an IFRS (i.e. it is neither a standard nor
5.2.1 Overview 51 an interpretation) but simply the foundation on which all IFRSs are built. The CF:
5.2.2 Asset definition discussed in more detail 52 x states the ‘objective of general-purpose financial reporting’; &
Example 1: Asset – rent prepaid 53 x explains the various ‘concepts’ that underpin financial reporting. See CF SP1.1
Example 2: Asset – various 54 The ‘objective of general-purpose financial reporting’ (which, essentially, is to provide users
5.3. Liability definition 55 with useful information: see section 2.1) forms the foundation of the CF in that the concepts
5.3.1 Overview 55 contained in the CF all flow from this stated objective. See CF SP1.1
5.3.2 Liability definition discussed in more detail 56
Example 3: Liability – rent payable 58 In other words, to achieve a successful set of general-purpose financial reports, we must
Example 4: Liability – various 58 apply IFRSs, where these IFRSs are based on the concepts contained in the CF and where
5.4. Equity definition 59 these concepts flow from the stated ‘objective of general-purpose financial reporting’. We
5.5. Income and expense definitions 60 could say that these reports essentially have 3 foundations.
Worked example 4: Income definition 61
Worked example 5: Expense definition 61 Goal: General-purpose financial reports, which includes financial statements (see section 2)
Example 5: Expense – arising from a payable 62 Aim is to achieve the objective (foundation 1) by applying the IFRSs (foundation 3), the development of which are based on the
concepts in the CF (foundation 2).
Worked example 6: Income and expense – part of equity reserves 62
6. Recognition and derecognition 62
6.1. Recognition 62 Foundation 1: Foundation 2: Foundation 3:
6.1.1 The meaning of the term ‘recognition’ 62 Objective of financial reporting Conceptual Framework IFRSs (including interpretations)
Worked example 7: Recognising an asset and a liability 63 (see section 2) (see this chapter) (see chapters 3 – 27)
6.1.2 Recognition criteria 63 Our objective is to provide useful The CF lays out concepts that will help IFRSs are used to prepare financial
information. us achieve usefulness and is used as the reports.
6.1.2.1 Overview 63
basis on which IFRSs are developed.
6.1.2.2 Relevance 64
6.1.2.3 Faithful representation 64
6.1.2.4 The trade-off between relevance and faithful representation 64 1.2 Purpose of the CF The purpose of the CF is to
assist:
6.1.3 When an element is not to be recognised 64
The CF is has three purposes: to help the IASB in x the IASB to develop IFRSs.
6.2. Derecognition 64
developing IFRSs, to help those preparers of financial x preparers to create
statements who may need to create their own accounting accounting policies (rare)
7. Measurement 65
x all parties to understand and
policies (i.e. when either a suitable IFRS does not exist or interpret IFRSs. See CF SP1.1
7.1. Overview 65
an existing IFRS allows an alternative policy) and to help all
7.2. Different measurement bases 65
parties to understand and interpret the IFRSs. See CF SP1.1
7.2.1 Overview 65
7.2.2 Historical cost 66 1.3 The new CF and the history behind it
7.2.3 Current value 67 Conflicts with the CF
7.3. Factors to consider when selecting a measurement basis 67 The IASB issued a new CF in 2018. The IASB decided a If the wording of an IFRS is in
7.3.1 Overview 67 new CF was needed because it was noted that some of the conflict with a concept in the CF,
follow the IFRS – NOT the CF!
7.3.2 Relevance 68 concepts in the original CF (issued in 1989) seemed
7.3.3 Faithful representation 68 unclear, incomplete and had become outdated. As an interim measure, a partly revised CF was
7.3.4 Other considerations 68 issued in 2010. This was replaced by the completely revised CF in 2018. However, the CF, by its
very nature, will always be a work-in-progress and thus further revisions may be needed from time-
8. Unit of account 69 to-time. See CF SP1.4
9. Presentation and disclosure principles 69
The ‘2018 CF’ clarified certain concepts (e.g. prudence), included new concepts (e.g.
9.1. Recognition versus presentation and disclosure 69 derecognition) and updated certain concepts (e.g. new asset and liability definitions and
9.2. The principles of presentation and disclosure 70 recognition criteria). Interestingly, IFRSs issued before 2018 would have been based on either
the 1989 CF or 2010 CF, but yet these IFRSs have not been updated for the new 2018 CF. This
10. Concepts of capital and capital maintenance 71
means the wording in the older IFRSs may conflict with the wording of the new CF (e.g. IAS 37
10.1. Capital 71 specifically quotes the old liability definition, thus it conflicts with the 2018 CF). In all cases, if an
10.2. Capital maintenance and determination of profit 71 IFRS conflicts with the new CF, we must use the wording of the IFRS rather than the wording of
the CF (i.e. the CF never overrides an IFRS). The IASB will gradually resolve all such conflicts.
11. Summary 72

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Concepts currently contained in the CF include the: 2.2 Information to be provided in general-purpose financial reports
x Objective of general-purpose financial reporting (CF: ch 1);
2.2.1 Overview (CF 1.4; 1.3 & 1.12 – 1.23) Users make decisions based on
x Qualitative characteristics of useful financial statements (CF: ch 2);
x Financial statements and the Reporting entity (CF: ch 3); their potential returns…
The information included in general-purpose financial
x Elements of financial statements (assets, liabilities, equity, income, expenses) (CF: ch 4); A user’s potential returns is
reports is driven by the needs of users in making
x Recognition and Derecognition (CF: ch 5); based on the user’s assessment of the
x Measurement bases that may be used when measuring the elements (CF: ch 6);
decisions about whether to provide the entity with entity’s:
x Presentation and Disclosure (CF: ch 7); resources (section 2.1). However, the specific decision x Prospects of future net cash inflows
depends on who the user is (e.g. an investor or lender), x Management stewardship See CF 1.3
x Capital and capital maintenance (CF: ch 8).
and what potential return he needs to predict. For For users to make this assessment, they
The new CF (2018) is immediately effective for the IASB (and its Interpretations Committee), and example, an investor may need to predict potential future need financial reports to contain
thus all new IFRSs will be based on the new CF. However, preparers who need to create their own dividends and capital growth whereas a lender may need information about the entity’s:
accounting policies need only implement the new CF when preparing annual financial statements for x economic resources (A),
to predict the potential return of the loan principal amount
claims (L and Eq) and
periods beginning on or after 1 January 2020 (earlier application is permitted). See IASB’s CF ‘Project Summary’ plus interest income. See CF 1.3
changes in these resources & claims (I, E &
other transactions & events)
To make these predictions (of a specific potential return), x management‘s efficiency & effectiveness in
2. General-Purpose Financial Reporting (CF: Chapter 1 & CF: Chapter 3) users need information. To meet these needs, financial using the entity’s resources See CF 1.3-1.4
reports must include two categories of information about the entity; namely information about its:
2.1 Objectives and limitations of general-purpose financial reporting x economic resources, claims against the entity, and changes in those resources and claims See CF 1.4
x management’s efficiency and effectiveness in performing their responsibility to use the
The ‘objective of general-purpose financial reporting’ is to give users information that they will
entity’s economic resources. See CF 1.4
find useful in their decision making. However, this objective is not to provide all possible users
with all possible kinds of information for all possible kinds of decisions. 2.2.2 Users use this information to make two basic assessments

There are many users who may find our general-purpose The objective of ‘general-
Users use the abovementioned categories of information in making two basic assessments:
purpose financial reporting’
financial reports (financial reports) useful, but we only is: x ‘the prospects for future net cash inflows to the entity’ (let’s call this ‘assessment 1’); and
need to design them for 3 primary users: investors, x to provide financial information x ‘management’s stewardship of the entity’s economic resources’ (this is basically how
lenders and other creditors (existing or potential). These x about the ‘reporting entity’ (RE) management has cared for and handled the resources) (let’s call this ‘assessment 2’). See CF 1.3
primary users are those who are unable to demand that x that is useful to existing and potential
the entity ‘provide information directly to them’. Examples ‘investors, lenders & other creditors’
x in making decisions relating to providing
Interestingly, one assessment may also give insight into the other assessment. For example,
of other users who we do not need to consider include:
resources to the entity. CF 1.2 information that leads a user to assess management’s stewardship as being poor (assessment 2),
x management (they already have access to internal This chapter will simply refer to the: may lead the user to an unfavourable assessment of the prospects of future net cash inflows
financial information); and ‘entity’, ‘users’ and ‘financial reports’. (assessment 1).
x tax authorities (they are given other information based
on tax legislation). See CF 1.2 & 1.5 & 1.9-10 Examples of some of the Financial reports ≠ Financial statements (See section 3)
limitations of general- x Financial statements are a form of financial report
As the name suggests, financial reports need only include purpose financial reporting: x Financial statements do not need to include such a wide array of information – they only need to
financial information. Other information that our users x Only provides financial information show information about elements (assets, liabilities, equity, income and expenses). See CF 3.1 and 4.2
may need include, for example, information about the x Not designed for all users
x Not designed for all decisions
industry in which the entity operates, the political stability x Not exact information The terms economic resources, claims and changes ≠the elements (See section 5)
of the country in which it operates, general economic x Only provides historic information x ‘economic resources’ (ER) is similar to ‘assets’ (A), but not all ERs will meet the asset
conditions and even climatic conditions (especially useful x Not designed to show the entity’s value! definition (A).
for agricultural businesses). Users will need to find this information elsewhere. See CF 1.2 & 1.6 x ‘claims against the entity’ (claims) is similar to ‘equity (Eq) and liabilities (L)’, but not all
claims will meet either the equity definition (Eq) or liability definition (L).
There are many decisions that primary users may need to make, but when preparing the x ‘changes in these resources and claims’ (changes) often result in income & expenses, but,
financial reports, we need only provide information that will help users make decisions about not all such changes will meet the income definition (I) or expense definition (E).
whether to provide resources to the entity. The resources that users may consider providing
the entity with are categorised into: 2.3 Information about ‘resources, claims and changes’: position, performance
x equity/ debt instruments: whether to buy them, or if they already have, whether to sell or not; or other
x loans/credit: whether to provide financing or, if already provided, whether to require settlement;
x management actions: whether they wish to try to influence management actions that may affect 2.3.1 Overview
the entity’s economic resources (e.g. a user may have the right to vote on certain management
actions and would thus need to decide whether to exercise these rights). See CF 1.2 As already mentioned in section 2.2, financial reports provide two types of information about an
entity. However, the information about the ‘resources, claims and changes’ therein deserves a
Another important aspect of the objective of financial reports is that we are not trying to provide an little more explanation. Information about ‘resources, claims and other’ will provide insight
exact depiction of transactions and events. Instead, reports are filled with ‘estimates, judgements and into:
models’, which we base on the concepts contained in the CF (i.e. compliance with these concepts is x our financial position; and also
our goal). See CF1.11 x our financial performance and other events or transactions unrelated to financial performance.

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2.3.2 Resources and claims: financial position (CF 1.12 – 1.14)
Considering an entity’s economic resources with the claims against it, gives a user a good
idea of what is referred to as the entity’s financial position.
When one talks about an entity’s financial position, one is referring to a variety of strengths
and weaknesses, such as the entity’s:
x liquidity (the user can look at the nature of its assets to assess the entity’s ability to
convert its assets into cash if needed);
x solvency (the entity’s ability to pay its liabilities); and
x need for financing.
When a user assesses the economic resources and claims, he will not only be interested in the
amounts thereof but will also be interested in the nature thereof. In other words, users will assess
these strengths and weaknesses by analysing:
x the nature of the specific resources (e.g. an analysis of the entity’s resources may reveal that
management has invested in assets yielding high returns or, perhaps that it has invested in
technologically obsolete equipment or slow-moving inventory); and
x the nature of the specific claims against these resources (e.g. some loans are repayable soon
and some are repayable in a few years).
The balance between these resources and claims will also be important for a user to assess (e.g.
having assets that are difficult to convert into cash while at the same time having liabilities that are
repayable soon is not a good balance).
2.3.3 Changes in resources and claims: financial performance or other (CF 1.15 – 1.21)
The changes in an entity’s ‘economic resources and claims’ are caused by a combination of:
x the entity’s financial performance, being the net effect of:
 income earned, and
 expenses incurred; and
x other events and transactions unrelated to financial performance:
 equity contributions (e.g. issuing of equity instruments);
 equity distributions (e.g. dividends declared); and
 changes in assets and liabilities that did not increase or decrease equity. See CF 1.15 & 4.2
When a user analyses the financial information at Changes in:
x econ. resources (A's) &
reporting date, he not only wants to look at the resources
currently held by the entity and what claims are currently x claims (Ls & Eq)
held against it, but he will want to know the amount by are caused by either / both:
which these resources and claims have changed since x financial performance (e.g. profits)
the prior reporting date. x other reasons (e.g. issue of shares)
Furthermore, the user will want to know what caused the changes in these amounts.
The transactions and events that caused these changes can be categorised into (a) those
that relate to the entity’s financial performance and (b) those that having nothing to do with
financial performance. Financial performance refers to the income generated by the entity
compared with the expenses that have been incurred by the entity.
It is important for users to be able to distinguish between these two causes (financial
performance and other reasons). This is because, for example, an increase in resources (e.g.
bank) that was generated through performance (i.e. income exceeding expenses) is generally
a better indicator of the entity’s ability to generate future cash flows than an increase in
resources that was a result of securing financing (e.g. raising a loan).
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Financial performance is thus an indicator of the return on an entity’s economic resources.
Providing detail about what makes up the return (e.g. whether the income was purely from
sales or from a combination of sales income and interest income) will further help users to
assess the level of uncertainty regarding future cash flows. See CF 1.15-16
The transactions and events that make up this financial performance must be presented using
both the accrual basis of accounting and the cash basis of accounting (see section 2.3.4).
Information about the transactions and events that changed an entity’s resources and claims,
but were not caused by financial performance, must also be presented because it is useful to
users to have the complete picture of what caused all the changes. Examples of changes to
resources or claims that arise due to transactions that are not related to performance include:
x the receipt of a bank loan increases cash (resources) and increases loan liability (claims);
x an issue of ordinary shares increases cash (resources) and increases share capital (claims).
2.3.4 Presenting financial performance: accrual accounting and cash flow accounting
There are two methods of presenting financial performance: using accrual accounting and using
cash flow accounting:
x accrual accounting involves recording the effects of transactions and events in the period
in which they occur, even if the related cash flow occurs in another period: this basis of
accounting involves presenting income and expenses. See CF 1.17 – 19
x cash accounting involves recording the effects of these transactions and events in the
period in which the cash flows occur: this basis of accounting involves presenting the
cash effects from operations, investing or financing activities. See CF 1.20
Assessing past financial performance is generally useful in predicting future returns, but it is believed
that financial performance that has been depicted using The cash basis gives additional
accrual accounting is the best indicator of both past and useful information, which some
argue is essential because the
future performance. On the other hand, depicting financial
accrual system is inherently flawed in
performance using cash flow accounting continues to be that it allows for the manipulation of
useful in that it assists in assessing liquidity and solvency profits through using various accounting
and helps assess and understand the entity’s operations, policies and measurement methods.
investing and financing activities. See CF 1.17-1.20
3. General-Purpose Financial Statements (CF: Chapter 3)
3.1 Overview Financial statements (FS)
are a form of
Financial report (FR)
So far, we have discussed financial reports. However,
this section deals with financial statements. FR’s give info about ‘economic phenomena’
FS’s give info about ‘elements’
The following sections explain the difference between
financial reports and financial statements, the financial statement objective, the term
‘reporting entity’ and ‘reporting period’, the basic structuring of the financial statements
(financial position, financial performance and ‘other’) and the different methods of accounting
for financial performance.
3.2 Financial statements versus financial reports (CF: Chapter 1, 2 & 3)
General-purpose financial reports (financial reports) are not
A ‘general-purpose financial
the same as general purpose financial statements (financial statement’ is defined as:
statements).
x a particular form of general-purpose
financial report
Financial reports is an ‘umbrella term’ that includes financial x that provides information about the
statements: financial statements are simply a ‘particular reporting entity’s:
form’ of financial reports.  assets, liabilities, equity,
CF Defined terms
 income and expenses
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Financial reports provide a wider variety of information As was explained previously, users analyse the economic resources and claims to gain
than financial statements: The ‘economic phenomena’
valuable insight into the entity’s strengths and weaknesses such as its liquidity, solvency and
of an entity refers to its
x Financial reports provide information about: need for financing (see section 2.3.2). See CF1.13
 Economic resources, claims, and changes in these x Economic resources;
x Claims against it; and If an economic resource meets the definition of an asset and if a claim meets either the
‘economic resources and claims’
x Changes in these resources and claims definition of a liability or equity, and the recognition criteria are met, it will appear in the
(the three of these are referred to as information See CF 2.2
statement of financial position. If it meets the definitions but does not meet the recognition
about the entity’s ‘economic phenomena’); and
criteria, but is considered to be useful information, it will be presented in the notes to the
 Management efficiency and effectiveness in using resources. See CF 2.2 & CF 3.1 statement of financial position (see section 3.4.3).
x Financial statements provide information about:
 Only those economic resources that meet the definition of an asset, 3.4.2 Statement of financial performance
 Only those claims that meet the definition of either a liability or equity, and
 Only those changes in resources and claims that meet the definition of income or expenses. See CF 3.1 The statement of financial performance contains information about the income and expenses
that have been recognised. See CF 3.3 (b)
Thus, whereas ‘financial reports’ give information about all economic phenomena as well as x Income reflects the changes in the resources and claims that meet the income definition.
management efficiency and effectiveness, ‘financial statements’ give information about only those Examples include sales, rent and interest earned. (See section 5.5)
economic phenomena that meet the definition of the elements: assets, liabilities, equity, income and x Expenses reflects the changes in the resources and claims that meet the expense
expenses (see section 5). See CF3.1 definition. Examples include the cost of sales, rent and interest incurred. (See section 5.5)

Important: an element is not always recognised! Although the CF refers to this as the ‘statement of financial performance’, the CF does not
Not all transactions and events are elements and not all elements are recognised. stipulate that this must be the title of the statement. In fact, this statement could even be
x For a transaction or event to be an element, it must meet the definition of an element (see section 5). presented as either one statement or two statements. A variety of titles are possible (e.g.
x For an element to be recognised (which means recording it in the journals and ledgers), it must also meet income statement, statement of profit or loss, statement of comprehensive income etc).
the recognition criteria (see section 6).
If useful, financial statements must provide information about all elements, whether they were recognised or not. In this textbook, we will generally present the statement on financial performance as a single
statement and will use the title ‘statement of comprehensive income’. This is covered in more
3.3 Objective of financial statements (CF 3.2) detail in chapter 3.
The objective of financial
statements (FSs) is:
The objective of financial statements is to provide users with 3.4.3 Other statements and notes
x to provide financial information
useful financial information about the reporting entity’s
x about the reporting entity’s We use other statements and notes to the financial statements to provide the following extra
elements: assets, liabilities, equity, interest and expenses. x assets, liabilities, equity, income & expenses
information:
x that is useful to users of FSs
3.4 Structure of financial statements (CF 3.3) - in assessing the prospects for ‘future x the nature of and any risks arising from assets and liabilities that have been recognised Note 1
net cash inflows’ to the reporting x the nature of and any risks arising from assets and liabilities that have not been recognised Note 1
To provide information about these elements in a way that entity, and x anything else that the IFRSs may require us to disclose regarding any of the five elements
- in assessing ‘management’s stewardship’
will be useful to users, the financial statements are of the entity’s economic resources. CF 3.2
(assets, liabilities, equity, income and expenses) that have been recognised Note 1
provided as a set of individual statements containing x how the various estimates in the financial statements were made, in other words, information
carefully categorised information about these elements. about the methods, assumptions and judgements used Note 1
x information about the cash flows Note 2
The CF does not dictate the title that must be used for x information about the contributions from and distributions to holders of equity claims. Note 3
each or the detail to be contained in each, but the CF A set of FSs includes a:
refers to them as the: Notes:
x statement of financial position, x Statement of financial position 1. This information will be found in the notes to the financial statements
x statement of financial performance, x Statement of financial performance 2. This information will be found in the statement of cash flows and in the notes to the financial statements
x other statements and notes. See CF 3.3 x Other statements and notes 3. This information will be found in the statement of changes in equity and in the notes to the financial
statements
3.4.1 Statement of financial position
3.4.4 Summary of how information is structured in financial statements
The statement of financial position contains information about the assets, liabilities and equity
that have been recognised. See CF 3.3 (a) Financial statements include information about the elements, where this information is
categorised into information that reflects on the entity’s:
x Assets are the economic resources that meet the asset definition. Examples include
goodwill, equipment, trade receivables and cash. (See section 5.2) x financial position,
x change in financial position that arose due to:
x Liabilities are the claims against an entity that meet the liability definition. Examples
include borrowings, trade payables and bank overdrafts. (See section 5.3) – the entity’s performance and
– other reasons.
x Similarly, equity reflects the claims against an entity that meet the equity definition.
Examples include ordinary share capital. (See section 5.4)

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Element Description If the reporting entity is a group of entities:

Assets Economic resource that meets the definition of an asset Section 5.2 Position x in which one of the entities has control over the other/s (the controlling entity is called a
Liabilities Claims that meet the definition of a liability Section 5.3 Position parent and the rest are called subsidiaries), then the financial statements are called
consolidated financial statements.
Equity Claims that meet the definition of equity Section 5.4 Position
x in which there is no control involved, then the financial statements are called combined
Income Changes in economic resources and claims that meet the Section 5.5 Performance
definition of income*
financial statements.

Expense Changes in economic resources and claims that meet the Section 5.5 Performance If an entity is a parent in a group of entities, but it wishes to provide information about its own elements,
definition of expense *
separately from that of the group, then it can do so in the notes to the consolidated financial statements
Other items Changes in economic resources and claims that do not meet Section 5.5 Other or it can produce an entirely separate set of financial statements about itself, in which case these ‘single-
the definition of income/ expense because they are:
entity’ financial statements must be called unconsolidated financial statements so as not to be confused
- Contributions from holders of equity claims (e.g. an
issue of shares to ordinary shareholders) with its consolidated financial statements. See CF 3.11 and 3.17
- Distributions to holders of equity claims (e.g. dividends
declared to ordinary shareholders) * Conflict between CF and pre-existing IFRS:
* Notice: information relating to the ‘changes in economic resources and claims’ is presented in two separate categories – those that The heading unconsolidated financial statements conflicts with the requirements of pre-existing IFRSs where
arose due to performance and those that arose due to other reasons.
the heading separate financial statements are used instead (see IAS 27). However, wherever conflicts arise between the
CF and pre-existing IFRSs, we must remember to apply the pre-existing IFRS.
3.5 Summary comparison: financial statements versus financial reports
Financial statements are more narrowly-focussed than financial reports, as illustrated in the 3.7 The reporting period (CF 3.4 – 3.7)
table below, which compares their definitions and objectives:
Financial statements provide information about an entity for a ‘specified time-period’, called a
reporting period. The reporting period is normally one year (annual reporting) but may also be
Reports versus statements – comparison of their definitions and objectives
provided for longer or shorter time-periods, such as 6-months (interim reporting). Financial
statements obviously need to clearly define the reporting period to which it relates.
General-purpose financial reports General-purpose financial statements
Are defined as: Are defined as: Information relates to the reporting period through the presentation or disclosure about:
x a report x particular form of general-purpose financial reports
x assets, liabilities and equity (whether recognised or not) that:
x that provides financial information x that provides information
x about the reporting entity’s: x about the reporting entity’s:  existed at the end of the reporting period, called the reporting date (if they are
 economic resources, claims against the entity and  assets, liabilities, equity, income and expenses. recognised, we present their closing balances as at the last day of the reporting period in
changes in those economic resources and claims CF Defined terms the statement of financial position and if they are not recognised, their values on this day
x that is useful to primary users will be disclosed in the notes)
x in making decisions relating to providing resources  existed during this period (this information would appear in the reconciliations between
to the entity. CF Defined terms the opening and closing balances, disclosed in the notes)
The objective is to: The objective is to:
x income and expenses for the entire time-period. See CF 3.4
x provide financial information x provide financial information
x about the reporting entity x about the reporting entity’s:
Predictions:
x that is useful to users in making decisions about  assets, liabilities, equity, income and expenses
providing resources to the entity See CF 1.2
Financial statements include historic information covering the reporting period and would only include
x that is useful to users
forward-looking information to the extent that it is useful in understanding the historic information (i.e.
To make these decisions, users will need to assess: x in assessing:
assets, liabilities and equity at the reporting date, and income and expenses for the reporting period). For
x prospects for future net cash inflows to the x prospects for future net cash inflows to the
entity; and entity; and
example, if an asset’s balance at reporting date (a historic figure) is measured based on future cash
x management’s stewardship of the entity’s x management’s stewardship of the entity’s
flows, disclosure of these future cash flows may be considered useful to the user and may thus be
economic resources See CF 1.3 economic resources See CF 3.2 included in the notes to the financial statements. However, management’s strategies and budgets for the
In order to make these assessments, the financial future are not included in the financial statements. See CF3.6
reports must contain information about:
x the economic resources, claims against the entity Events after the reporting period:
and changes in these resources and claims; and Obviously, after the reporting period ends and while we are busy preparing the financial statements,
x the efficiency and effectiveness with which transactions and events continue to occur. If a transaction or event occurs after the reporting period ends
management has used economic resources. See CF 1.4 that we believe provides information that relates to the elements included in the financial statements and
which may be considered useful to users, we would include this information in the financial statements.
3.6 The reporting entity (CF: Chapter 3) A reporting entity is: For example, we may have included a liability at the end of the reporting period that relates to a future
court case and this court case may now have begun. Information about this court case, even though it
Financial statements are prepared for a specific reporting entity, x an entity that
x is required/ chooses to
has begun after the reporting period has ended, may be considered useful to our users. See CF3.7
which is an entity that either chooses or is required to prepare x prepare F/Ss. CF 3.10
financial statements. These statements need to clearly define Prior reporting periods:
the reporting entity to which it relates. A reporting entity can be a variety of things including a To help users assess whether the entity is improving or deteriorating, information relating to at least
single entity, part of an entity or even a group of entities. one prior period must be provided as comparative information. See CF 3.5

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3.8 The going concern assumption (CF 3.9)
Unless the financial statements state otherwise, users may assume the financial statements
provide information about a reporting entity that ‘is a going concern that will continue in
operations for the foreseeable future’. In other words, users may assume that the entity does
not need/intend to liquidate or cease operating. If this assumption is inappropriate, this fact
plus the basis upon which the financial statements were then prepared (e.g. measuring
assets at liquidation values instead of fair values) must be disclosed.
4. Qualitative Characteristics and Constraints (CF: Chapter 2)
Materiality is not a qualitative characteristic but is simply used in deciding what information would be
relevant to our users.
When deciding if something (in terms of its nature or magnitude, or both) is material, and thus relevant,
we ask ourselves whether it would be reasonable to expect that omitting, misstating or obscuring it
might change our primary users’ decisions.
There is no one specific materiality threshold because information that is material to one entity may not
be material to another entity and also depends on the situation: materiality is entity-specific. Clearly,
deciding whether something is material will need our professional judgement. Materiality is explained in
more detail in chapter 3. See CF 2.11 & IFRS Practice Statement 2

4.1 Overview There are 2 types of QC Worked example 1: Materiality is entity-specific (quantitative materiality)
x Fundamental QCs Entity A is a small business with total income of C50 000. It decides all income types
Qualitative characteristics and constraints affect all forms of these are essential for usefulness with totals exceeding C15 000 are individually material. Thus, it separately discloses its
financial information, whether contained in financial x Enhancing QCs
‘sales income’ (C22 000) and ‘service income’ (C18 000) and aggregates all remaining income types
these improve usefulness
statements or other financial reports. However, this chapter (e.g. interest, dividends, rental), which it discloses as ‘other income’ (C10 000).
and remaining textbook focuses on financial statements. See CF 2.3
Entity B is a larger business with total income of C1 400 000. It has many different types of
For financial statements to be useful to its users, it must have certain qualitative characteristics, income, each of which exceeds C90 000, but its main source of income is sales of C850 000. Entity
which the CF separates into two types: B decides an appropriate materiality threshold for its income is C800 000, thus disclosing two types
of income: ‘sales income’ (C850 000) and ‘other income’ (C550 000).
x Fundamental qualitative characteristics: these are essential for usefulness.
x Enhancing qualitative characteristics: these improve usefulness. See CF 2.4-2.5 Comment: The materiality threshold of C15 000 used by A is clearly not appropriate for B, otherwise
B would need to list each of its many income types, and thus clutter its financial statements with
Let’s look at what these characteristics are, how to apply them and let’s also give some thought to irrelevant information. Cluttering the financial statements with immaterial information would also risk
the cost constraint we would face when trying to ensure that our financial statements have them. obscuring material information. Thus, a quantitative materiality level (magnitude) is entity-specific.
Please note, however, that qualitative materiality (nature) would also be entity-specific.
4.2 Fundamental qualitative characteristics (CF 2.5)
4.2.2 Faithful representation (CF 2.12 – 2.19) Faithful representation
There are only 2
For financial statements to be useful, the information they means information must:
Fundamental QCs:
hold must be both relevant and a faithful representation. x Relevance; &
Faithful representation refers to the depiction of substance ‘faithfully represent the
We always start by deciding what information is most over form. This means, if something’s legal form differs from substance of the phenomena
x Faithful representation. See CF 2.5
relevant and then checking to make sure that information its substance, then we must rather portray its substance… not that it purports to represent’.
See CF 2.12
provides a faithful representation of the economic phenomenon it purports to represent. its legal form.
To be a faithful representation, the
information will need to be:
4.2.1 Relevance (which involves materiality) (CF 2.6- 2.11) For example: a legal contract may state that an entity is x complete,
Relevant information is: leasing an item from someone (legal form = lease), but the x neutral and
When deciding what is relevant, we must consider whether entity may be leasing the item for its entire useful life, in whichx free from error. See CF 2.13
x ‘capable of making a difference
it could make a difference in users’ decision-making. See CF 2.6 x in the decisions made by users’. case, the essence of the transaction is that the entity has actually purchased the item from someone
CF 2.6
who has also helped the entity finance its purchase (substance = purchase). In this case, instead of
Relevant information must recording the lease payments as a rental expense (legal form) we would record both the purchase of
Financial information is capable of making a difference if it have:
has either of the following or both: x Predictive value; and/or
the asset and the resultant liability (the substance), with the so-called lease payments being recorded
x Predictive value: x Confirmatory value. See CF 2.7 as a repayment of the liability. See CF 2.12
the information need not include predictions or forecasts but must simply be information that users
In order to achieve faithful representation, the financial information given to users must be complete,
can use as ‘inputs’ in their own predictions and forecasts.
neutral and free from error. See CF 2.13
x Confirmatory value: Complete means depicting:
the information is confirmatory if it is information users can use as ‘feedback’ on their previous 4.2.2.1 Complete (CF 2.14) x all information
x necessary for a user to
predictions. For example, giving information about the current year’s revenue helps users assess if x understand the phenomenon
their previous revenue predictions were accurate or not. See CF 2.7 – 2.9 Financial statements must be complete. Completeness means being depicted CF 2.14
giving all information (words and numbers) that a user needs
Information is material:
Incidentally, information that is confirmatory can also be to understand whatever phenomenon is being described. For example, if the phenomenon is an
x if omitting/ misstating/ obscuring it asset, we should:
predictive. For example: information about the current
x could reasonably be expected to
year’s revenue not only helps users confirm their previous influence decisions x describe the nature of the assets e.g. machines (describe nature);
predictions but also helps users predict the future. x that the primary users of general x give relevant numerical information e.g. cost, depreciation etc (amounts);
purpose financial reports make
IAS 1.7 (extract) x describe what the numbers mean e.g. depreciated cost (describe the information);
Relevance is obviously affected by materiality. Materiality x explain how we got to these amounts e.g. depreciated cost is calculated at cost less
is a term you will encounter very often in your studies and is thus important for you to understand. depreciation calculated using a nil residual value and a ten-year useful life (explanations).

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4.2.2.2 Neutral (involves prudence) (CF 2.15-17)
For financial statements to be neutral, we must not select Neutral means:
x free from bias.CF 2.15
or present information in a way that is biased. When there
is bias in the financial statements, it means the information Bias means :
x manipulation to get a
has been manipulated, whether consciously or unconsciously, response that is either
so that users interpret it in a favourable or unfavourable way x favourable/ unfavourable.
(this could happen by merely over-emphasizing one piece of
information or de-emphasizing another!).
Prudence is the:
To help us remain neutral, we must exercise prudence. x exercise of caution when
x making judgements
Exercising prudence means that, wherever there is a level of x under conditions of
uncertainty.CF 2.16
uncertainty in the information, we must exercise caution. Being
prudent (cautious), means we are being careful not to:
x overstate assets and income and understate liabilities and expenses (i.e. take care not to be
biased towards showing a favourable picture); or
x understate assets and income and overstate liabilities and expenses (take care not to be
biased towards showing an unfavourable picture).
4.2.2.3 Free from error (CF 2.18-19) Free from error means:
x no errors/ ommissions in
x description of phenomena &
To be useful, information must be a faithful representation, and x selection & application of
to be a faithful representation means it must be ‘free from error’. processes used to
However, information that is ‘free from error’ does not mean it produce the information.
CF 2.18 (reworded)
must be 'accurate in all respects’.
Free from error ≠ perfect
Sometimes amounts in our financial statements are directly observable and thus accurate (e.g. an
investment in listed shares could be valued accurately at the share price quoted on a stock exchange).
However, in other cases, there is no directly observable price and our amounts will need to be estimated
(e.g. a provision for costs relating to a lawsuit).
Having estimates in our financial statements is entirely normal but it does introduce what is referred to as
‘measurement uncertainty’. By its very nature, at the time of making an estimate, we could never prove it
is accurate. However, even very high levels of measurement uncertainty do not necessarily mean the
information is not ‘free from error’.
‘Free from error’ simply means that there are no errors or omissions in either the description of the
phenomenon or the selection and application of the processes used to produce the information. This
means that estimated amounts in our financial information can be said to be free from error if:
x the financial information describes it as an estimate,
x the financial information describes the nature and limitations involved in making the estimate
(e.g. we explain that a provision relates to a legal claim where the court case is still in
progress and thus that we are relying on our lawyer’s estimations), and
x there are no errors in the selection and application of the process used to develop them. See CF 2.18
4.2.3 Applying the fundamental qualitative characteristics (CF 2.21-22)
The information cannot be useful if it is relevant but not a faithful representation, or vice versa. It
must be both. The CF explains that the best way of achieving both is to:
Step 1 Identify the economic phenomenon that has the potential to be useful to the user.
Step 2 Identify what type of information would be most relevant.
Step 3 Determine whether the information is available and can be faithfully represented.
If the most relevant information is available and can be faithfully represented, you will have
satisfied the fundamental qualitative characteristics. If not, then identify the next most relevant
type of information and repeat the process (i.e. figure out whether this type of information is
available and then figure out whether it can be faithfully represented).See CF 2.21
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There is often a trade-off between presenting relevant information that is also a faithful
representation of the phenomenon, and vice versa. What is important is that we can conclude that
both fundamental qualitative characteristics are met.
For example, sometimes the most relevant information about a phenomenon has such a high
degree of measurement uncertainty that we must question if it is a faithful representation of its value.
x In some cases, we may still be able to conclude that it is a faithful representation by simply
highlighting that this information is an estimate and explaining all the related uncertainties.
x However, in other cases, we may need to give up on the idea of presenting that piece of
information and choose the next most relevant information that has a lower level of
measurement uncertainty and which allows us to conclude that it is a faithful representation
of the phenomenon.
Worked example 2: Relevant information that is also a faithful representation
The government gives us land at no cost. Land is the phenomenon we need to depict.
We can faithfully represent land (the phenomenon) at its ‘cost’ (nil), but we decide cost is not
the most relevant information. Instead, we decide that the most relevant information is its ‘fair value’.
We then establish that we can estimate fair value based on current market valuations of similar properties
and that the measurement uncertainty relating to this estimate is low enough for us to conclude that the
estimated fair value would be a faithful representation.
Conclusion: We decide to measure land at its fair value because it is relevant and would be a
faithful representation and thus would be useful information (relevance + faithful representation =
useful information). See CF 2.4
Worked example 3: Balancing relevance and faithful representation
An entity invests in land. This investment property is the phenomenon we need to depict.
We decide that the most relevant information about this land is its ‘fair value’. However,
its fair value is not directly observable and thus we need to estimate it.
Unfortunately, there are no similar properties or market valuations available and thus we need to
estimate it using other data. We also realise this estimate will have such a high degree of
measurement uncertainty that we will not be able to conclude that the estimate is a faithful
representation of the property’s fair value.
In this case, we decide that the next most relevant information about this property is its ‘cost’ and
conclude that, since it needs no estimate, cost is a faithful representation of the property.
Conclusion: We thus decide that the information we must provide is ‘cost’, since it is both relevant
and a faithful representation, and thus it is useful.
This is an example of having to reduce the relevance of the information in order to achieve a
faithful representation (i.e. we are forced to provide information that is not as relevant as we
would have liked). [This is because: relevance + unfaithful representation ≠ useful information]
4.3 Enhancing qualitative characteristics (CF 2.23 - 38)
Enhancing QCs (4):
Once information is both ‘relevant’ and ‘faithfully represented’ x Comparability
(fundamental qualities), we have useful information. x Verifiability
x Timeliness
See CF 2.23
x Understandability.
We then try to enhance this usefulness by ensuring that the
information is also ‘comparable’, ‘verifiable’, ‘understandable’ and produced on a ‘timely’ basis.
These are the 4 enhancing qualitative characteristics. See CF 2.23
4.3.1 Comparability (CF 2.24-29) Comparability enables users to:
x ‘identify & understand
Comparability allows users to identify similarities and x similarities in items, &
x differences among items’.
differences among items. Being able to compare items CF 2.25
helps users choose how to proceed with their decisions
(e.g. whether to invest in one entity or another entity).
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‘Consistency’ is not the same as ‘comparability’…it simply helps achieve comparability. See CF 2.26 4.3.4 Understandability (CF 2.34-36) Understandable
x ‘Comparisons’ need at least two items whereas information is:
Comparability ≠ Consistency Since our ultimate objective is usefulness, it makes sense
x ‘Consistency’ refers to the same methods being applied to x Classified, characterised &
x Comparability is the goal; that information must be understandable. For information to presented
one specific item, either: x Consistency helps achieve the x Clearly & concisely. CF 2.34
CF 2.26
be understandable, it must be clear and concise. See 2.34
 in a single entity across multiple periods; or goal.
 across multiple entities in a single period. However, some information, by its very nature, may be difficult to understand. We may not simply
Consistency helps enable leave it out on the basis that it is not easily understandable. This is because this would mean that
In other words, users find information more useful if they comparisons:
the financial statements would not be complete and thus potentially misleading. Thus, if something
can make comparisons: x across multiple entities; and is difficult to understand, we simply need to take extra care in how we present it and give extra
x across multiple periods.
x from one year to the next: Transactions of a similar See CF 2.26 disclosure if we believe it may improve the understandability thereof. See CF 2.35
nature should be recognised, measured and presented by
an entity in the same way that they were in prior years (consistently) (e.g. an entity should As preparers of financial statements, when we try to explain inherently difficult information,
ideally use the same methods to measure inventory every year). This consistency enables the CF allows us to assume that the user:
comparisons across multiple periods, which may help identify trends (e.g. a trend in x is reasonably knowledgeable;
liquidity may help creditors decide if they should increase or decrease credit limits). x will carefully review and analyse the information we provide; and
x from one entity to the next: Transactions of a similar nature should, ideally, be recognised, x will seek help from an advisor for complex issues. See CF 2.36
measured and presented by all entities in the same way. This consistency enables
comparisons across multiple entities (e.g. this would be useful to potential investors deciding
4.3.5 Applying the enhancing qualitative characteristics (CF 2.37-38)
which entity to invest in). Unfortunately, not all entities comply with IFRSs and even within the
IFRSs, there are so many methods permitted that would still result in faithful representation,
Information that does not have the fundamental qualitative characteristics (FQCs) is not useful and
that this level of comparability is difficult.
cannot be made useful simply by ensuring it has the enhancing qualitative characteristics (EQCs).
4.3.2 Verifiability (CF 2.30-32) Verifiability means that:
x ‘different knowledgeable and Conversely, if we have a phenomenon that we could describe in two different ways, each way being
independent observers equally relevant and faithfully represented (i.e. meeting both FQCs), we could then consider the
Verifiability helps assure users that the information has been x could reach consensus, enhancing qualitative characteristics (EQCs) of each way to help us decide which way is ultimately a
independently assessed by knowledgeable observers and although not necessarily
complete agreement,
better way of describing it.
found to be faithfully represented. Thus, verifiability gives users
a measure of confidence in the information presented. x that a particular depiction
(e.g. description/ amount) is a We must maximise the enhancing qualitative characteristics We must try to maximise
faithful representation’. where possible. However, this process involves a balancing act, the enhancing QCs but also
CF 2.30
An amount need not be a ‘single point estimate’ to be verifiable. because to apply one enhancing qualitative characteristic may be careful because:
Instead, a range of possible amounts and their probabilities could be verifiable. See CF 2.30 mean that another one (an EQC or even a FQC) is diminished. x maximising one QC (e.g.
understandability)
For example: x may reduce another QC (e.g.
Some information may not be verifiable (e.g. predictions and certain explanations). If information is
not verifiable, it should be clearly identified as such so that users can decide if they want to use this x for information to be a faithful representation (a FQC), it timeliness).
information in their decision-making. See CF 2.32 may mean that it is not as timely (a EQC) as we wanted;
x for information to be more relevant (a FQC) in the long-term, we may need to apply a
Verification could be direct or indirect: new IFRS, and this may need to be done prospectively, which would mean comparability
x Direct verification means verifying something (e.g. an amount) through direct observation: (a EQC) may need to be temporarily reduced.
for example, a bank balance can be verified by looking at the bank statement;
x Indirect verification means verifying something (e.g. an amount) by checking inputs and
4.4 The cost constraint on useful information (CF 2.39-43)
recalculating the outputs: for example, an inventory balance can be verified by checking
There are often large costs involved in reporting financial information. These costs obviously
the inputs (number of units on hand and cost per unit), checking the correct process to
increase as one tries to achieve perfection in the financial statements. We therefore need to
be applied (e.g. the first-in-first-out formula) and recalculating the balance. See CF 2.31
be careful that the benefit justifies the cost. At the same time, however, we must also bear in
mind that if we, as the providers of financial information, do not incur these costs then our
4.3.3 Timeliness (CF 2.33) Timeliness means
information is:
users would bear extra costs by having to obtain missing information from elsewhere.
Information needs to be made available timeously so that users x ‘available to decision-makers
Financial reporting that is relevant and a faithful representation allows users to make
are able to use it in their decision-making. Most information x in time to be capable of
influencing their decisions’.
decisions with confidence. This in turn improves the overall economy.
needs to be available soon after year-end to be useful.
CF 2.33
For example: the ‘2016 financial statements’ of a business are
When the IASB develops the various IFRSs that stipulate the information to be provided, it
not relevant to a user who is trying to decide, in 2020, whether or not to invest in that business.
carefully considers the expected costs involved in applying these standards. Thus, in general,
However, old information can actually still be useful for users who are looking at trends.
the cost of providing information required by IFRSs will normally be justified by the benefit.
This is, however, a subjective issue due to the peculiarities of each entity (what may be cost-
Interestingly, this race against time may impair other qualities (e.g. rushing the publication of
effective for a large multi-national entity may be too expensive for another smaller entity).
financial statements may result in faithful representation being adversely affected).
Professional judgement is thus necessary to decide if the benefit justifies the cost.

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5.2 Asset definition (CF 4.3-4.25)

5. Elements (CF: Chapter 4)
5.2.1 Overview
5.1 Overview
The new 2018 CF has introduced a new asset definition. A comparison of the new asset
Just as there are 26 letters in our alphabet, which we use to communicate all sorts of information, definition with the old asset definition, per the previous 2010 CF, is shown below.
there are 5 elements in our accounting system that we use to communicate financial information.
Using financial statements, we describe an entity’s: OLD 2010 CF NEW 2018 CF
x financial position using just 3 elements: assets, liabilities and equity. An asset was defined as: An asset is defined as:
x financial performance using just 2 elements: income and expenses. x Resource x A present economic resource Note 1
x Controlled by the entity x Controlled by the entity
As mentioned in previous sections, transactions and events lead to an entity’s economic x As a result of past events x Resulting from past events See CF 4.3
phenomena: its economic resources, claims against the entity and changes in these x From which future economic benefits are Note 1: An economic resource is defined as:
resources and claims (see section 3). expected to flow to the entity x a right that has
See CF 4.4
x the potential to produce economic benefits
x Economic resources are similar to assets, but not all resources are assets. For a resource
to be an asset, it must meet the definition of an asset.
For an asset to exist there must be a present economic resource (defined as ‘a right that has the
x Claims could be liabilities or equity, but not all claims will meet one of these definitions. potential to produce economic benefits’) and it must be controlled by the entity as a result of past
x Similarly, changes in resources and claims could be income or expenses, or even JUST a events (in other words, the event that lead to the control must have occurred before reporting date).
movement in equity, but these changes will not necessarily meet these definitions.
The most important aspects of this asset definition are to identify: Economic resource (ER):
Whereas financial reports include all the entity’s economic phenomena, the financial statements x whether there is an economic resource (which is a right An ER exists if there is:
include only those economic phenomena that meet the definition of one of these elements. If an that has the potential to produce economic benefits), x a right (not an object):
economic phenomenon meets the definition of one of these elements, we then need to decide x whether the entity controls this right, and e.g. right to use an asset
whether to recognise (i.e. journalise) it. In other words, some elements might not get recognised. An x that the right exists at reporting date due to a past event. x that has the potential (even
element will only be recognised if it meets the recognition criteria (see section 6). If it is not if it is remote) to produce
economic benefits (EB):
recognised, the element will not be included in either the statement of financial position or statement The most significant change brought about by the new asset e.g. cash inflow or a reduced
of financial performance, but may be included in the notes to the financial statements. definition is that, when trying to decide whether an asset exists, cash outflow
we must no longer focus on the ‘object’ but rather the ‘rights’ that it represents (because an asset is
The new 2018 CF has introduced new definitions for these elements. These are depicted below an ‘economic resource’, which is a ‘right that has the potential to produce economic benefits’). For
Asset Liability example, when deciding if a particular machine is an asset, we don’t look ‘at the object’, but rather
CF 4.3 – 4.25 CF 4.26-4.47 we look ‘into the object’ to see whether we can identify any rights ‘floating around’ in it (e.g. our
x A present economic resource Note 1 x A present obligation Note 2
machine may give us the right to make muffins) and whether any of these rights has the potential to
x Controlled by the entity x To transfer an economic resource Note 1 produce economic benefits (e.g. selling the muffins would produce a cash inflow).
x Resulting from past events x Resulting from past events
A right could be many things, such as a right to receive cash (e.g. receivable), a right to receive
Note 1: An economic resource is defined as: Note 2: An obligation is:
goods or services (e.g. prepaid electricity), a right to use an asset (e.g. a machine) or a right to sell
x a right that has x a duty that the entity has
an asset (e.g. inventory) etc. See CF 4.6
x the potential to produce economic benefits x no practical ability to avoid.

However, for a right to be an ‘economic resource’, it must have the potential to produce economic
Equity benefits for the entity. Depending on what the right is, this ‘potential for economic benefits’ could
CF 4.63-4.67
come in many forms, such as the right to simply receive cash (or another economic resource),
x The residual interest in the entity’s assets produce a cash inflow or avoid a cash outflow etc. For example, inventory represents:
x After deducting all its liabilities x the right to sell the asset, and
x this ‘right to sell’ has the potential to produce economic benefits, (e.g. in the form of cash), if the
Expense Income entity is able to sell the inventory.
CF 4.69 & 4.71-72 CF 4.68 & 4.71-72
Control over the ER
Control exists if we can:
x A decrease in assets or increase in liabilities x An increase in assets or decrease in liabilities The potential to produce economic benefits does not have to be
x direct the use of the ER &
x Resulting in decreases in equity x Resulting in increases in equity certain, probable or even likely. Thus, even if the aforesaid x obtain its benefits
x Other than distributions to holders of equity claims x Other than contributions from holders of equity claims inventory was unlikely to ever be sold, the entity would still Generally able to prove control
conclude that it has an asset since the right has the potential, through the ‘ability to enforce
however remote, to produce economic benefits. legal rights’
Please note! IFRSs that were developed before the publication of the 2018 CF (i.e. pre-existing
IFRSs) have not yet been updated by the IASB for the new definitions. The reason for this is that
the IASB believes the outcome will, in most cases, be the same whether we apply the old definitions For a right to meet the definition of an asset, it must be controlled by the entity. The entity has
or the new definitions. However, the IASB has stated that it will update these pre-existing IFRSs control over a right if it has the ‘ability to enforce legal rights’ (e.g. if the right arises through a
over time, as and when conflicting outcomes are identified. The IASB has emphasized that preparers of financial legal contract). However, if the entity cannot establish that it has ‘legal enforceability’ over its
statements should continue applying these pre-existing IFRSs and that, wherever there is a conflict between the
right, then it will simply have to prove that it can both ‘direct the use’ of the resource (i.e. that it
requirements of a pre-existing IFRS and the new 2018 CF, the preparers must remember that the requirements
of an IFRS must always override the principles in the CF. has the ability to decide how it is used) and ‘can obtain the benefits’ from the resource.

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5.2.2 Asset definition discussed in more detail
Let us know look at the definition in more detail.
x There must be a present economic resource
An economic resource is defined as ‘a right that has the potential to produce economic benefits’
 The right:
The fact that an economic resource is a ‘right’ means it is not a physical object. The right
must have the potential to produce economic benefits for the entity in order for it to be an
‘economic resource’. For example, if we own inventory, the economic resource is not the
physical goods but rather the right to sell them. Thus, depending on the item, the right could
be many things. For example:
x Accounts receivable represents the right to receive cash
x Expenses prepaid represents a right to receive goods or services
x Intangible asset may represent a right to use a patent, or lease it or sell it etc
x Inventory represents a right to sell an object.
Interestingly, since an asset is no longer an ‘object’ but rather the ‘right’ that it represents, it
means that, whereas in the past a single object would have been identified as a single
asset, a single object that includes multiple rights (called a ‘bundle of rights’ or ‘set of rights’),
may now need to be identified as multiple assets. For example, if an entity owns a vehicle
(the ‘object’), the entity would probably have the right to use the vehicle, sell it or even lease
it to someone else. In this case, the ‘object’, which is the vehicle, could be identified as three
assets. However, the CF concedes that where a set of rights arises from ‘legal ownership’ of
an object, it will generally make sense to account for the ‘set of rights’ as one asset (i.e. as
one single ‘unit of account’). Thus, in this case, it would not make sense to identify these
rights as separate assets but to rather identify the ‘set of rights’ as the asset. Similarly, the
CF also notes that describing this ‘set of rights’ as the physical object (i.e. describing it as a
vehicle rather than as ‘the right to use a vehicle’) will ‘often provide a faithful representation
of those rights in the most concise and understandable way’. See CF 4.12
The various forms that rights might take can be categorised into those that correspond to an
obligation of another party, and those that do not:
x rights that correspond to an obligation of another party include, for example, a
right to receive cash (e.g. accounts receivable represents the right to receive cash, but
there is another party who has the obligation to pay us the cash), and the right to
receive services (e.g. electricity prepaid represents the right to receive electricity, but
there is another party who has the obligation to provide us with the electricity; and
x rights that do not correspond to an obligation of another party include, for
example, the rights involving physical or intangible objects, such as the right to use
property, plant and equipment, investment property and inventory (physical objects) or
the right to use patents, trademarks and intellectual property (intangible assets). See CF 4.6
A right may arise through any number of ways. For example, a right could arise as a result
of a contract or through legislation or could arise as a result of the entity simply creating the
right (e.g. creating a ‘secret recipe’ that the entity then has the right to use). See CF 4.7
 Potential to produce economic benefits:
The right must have the potential to produce economic benefits.
For this potential to exist, the existing right must, in one circumstance, be able to produce
benefits for the entity (in excess of the benefits available to all other parties). See CF 4.14
The economic benefits that the right might produce could be many things. For example,
inventory is the right to sell the item, and where the potential economic benefits that could
be produced as a result of this ‘right to sell’, could be ‘cash inflows’. However, a right could
also produce the entitlement or ability to, for example, avoid a cash outflow or receive
another type of economic resource (i.e. another right).
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Importantly, this potential for economic benefits does not need to be certain or even likely –
the potential could even be just a remote possibility. Remember that, at this stage, when we
are looking at the asset definition, all we are trying to assess is whether an asset exists. If
there is a low probability of producing benefits, this would be considered when deciding:
x whether to recognise the asset (if information about this asset would still be considered
useful by our users, despite the low probability of benefits, we might still recognise it:
see section 6), and
x how it is to be measured (see section 7).
x This resource must be controlled by the entity
An entity has control if it has the present ability to both:
x direct the use of the economic resource (i.e. can the entity decide how to use the right), and
x obtain the benefits that flow from the resource (e.g. can the entity receive the benefits). See CF 4.20
Control also arises if you can prevent others from directing the use and obtaining the benefits.
The easiest way to prove control is if we have the ‘ability to enforce legal rights’. For example:
 We can control a right to use an asset being leased from someone else, because of the
existence of the lease contract, which gives us the ability to enforce our legal rights.
 Prepaid insurance gives us the right to receive future insurance cover (an economic
resource), which is a right that we can control because of the existence of the insurance
contract, since this contract gives us the ability to enforce our legal rights. See CF4.22
However, the ability to enforce legal rights is not necessary for there to be control. For example,
an entity may have a recipe that it has not patented (i.e. there is no legal document), but if the
entity can keep it secret and prevent others from directing the use of it and obtaining the benefits
from it, then control exists. See CF 4.20 & 4.22
x This resource must arise as a result of a past event
For a resource to be a present economic resource, it must have arisen from a past event, being
an event that occurred on or before the reporting date (last day of the reporting period).
Example 1: Asset – rent prepaid
Alpha rents office space from a landlord, at C10 000 per month. It uses this space to run
a business selling advice. At 31 December 20X4, it pays for the rent for January 20X5.
Required: From Alpha’s perspective, prove this payment is an asset at 31 December 20X4.
Solution 1: Asset – rent prepaid
Alpha has made a payment that has created an asset:
x There is a present economic resource (a right)
 There is a right to occupy the office space in January 20X5
 This right has the potential to produce economic benefits: the right to occupy the office
can be used to produce cash (e.g. by using the space to meet clients and sell advice).
x This resource is controlled by the entity
An entity has control if it has the present ability to:
 direct the use of the economic resource (i.e. if the entity can decide how to use it); and
 obtain the economic benefits that flow from the resource (e.g. whether the entity has
the ability to receive the flow of cash from the financial advisory business).
In this case, the entity’s ability to both ‘direct the use’ and ‘obtain the economic benefits’
can be proved through its ability to enforce legal rights. This is because of the combined
existence (1) of:
 the rental agreement (note, this agreement need not be written) and
 the prepayment of the rent.
(1) Depending on the terms of the contract, the existence of one without the other, would not give us
this right (e.g. if the contract existed but we had not prepaid the rent, then, at reporting date, we
would not have the right to decide how to use the office space or obtain any benefits from the
office space in January 20X5).
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x This resource is a result of a past event (iv) Land

There are two events that have led to the economic resource ((1) the signing of the rental x The present economic resource is
agreement (though please note that an agreement need not be in writing – what is - the right to direct the use of the land (e.g. we can decide when to use it and how to
important is that consensus between the two parties has been reached), and (2) the use it: we could decide to use the land as a public market-place or we could
prepayment of cash – as explained above, depending on the terms of the contract, the decide to use it by building a new manufacturing plant on the land)
signing of a rental agreement without paying for the January rent would typically not result - where the right has the potential to produce economic benefits: these benefits
in the right to occupy the space in January). could be in the form of an inflow of cash (e.g. cash inflows from the rental of
Both these events are past events since both events occurred on/before reporting date display tables, if we used it as a market-place), or it could be in the form of an
(31 December 20X4). inflow of other economic resources (e.g. if we used it to construct a manufacturing
plant, the land would, together with the plant, be generating inventory, which is
Example 2: Asset – various another economic resource)
The accountant is concerned that the new asset definition in the CF will result in certain x It is controlled through legal ownership
items, which are currently considered to be assets, no longer meeting the asset x The past event is the purchasing and obtaining control of the land.
definition, and vice versa. (v) Equipment
Required: x The present economic resource is
a) Briefly explain to the accountant whether his concerns are valid.
- the right to direct the use of the equipment (e.g. we can decide when to use it and
b) Using the ‘new’ asset definition per the 2018 CF, briefly explain whether the following items
how long to use it for – or even whether to keep it or sell it)
will still be considered to be assets:
- where the right has the potential to produce economic benefits, which could, for
(i) Inventory
example, be in the form of an inflow of other economic resources such as
(ii) Trade receivables
inventory (if the equipment was used to manufacture inventory) or could be in the
(iii) Cash at bank
form of an enhancement of another economic resource (e.g. if the equipment was
(iv) Land
used to construct another asset, such as a manufacturing plant), or it could be in
(v) Equipment
the form of a cash inflow (e.g. if the equipment was used to provide services).
(vi) Investment in shares (less than 10% holding)
(vii) Investment property x It is controlled through legal ownership
x The past event is the purchasing and obtaining control of the equipment.
Solution 2: Asset - various (vi) Investment in shares
a) The accountant’s concerns are not valid. The application of the new asset definition is x The present economic resource is
expected to result, in most cases, in the same outcome had the ‘old’ definition per the 2010 - the right to hold or sell these shares
CF been applied instead. Irrespective of this fact, the existing IFRSs continue to be applied by - where the right has the potential to produce economic benefits through the inflow
preparers of financial statements and these new CF definitions will only be used by the IASB of dividends or capital appreciation that will be realised through sale
to develop new IFRSs and interpretations. See CF BC4.21 x It is controlled through legal ownership (the share certificates)
b) The following proves how the following items will continue to meet the new asset definition: x The past event is the purchasing and obtaining control of the shares.
(i) Inventory (vii) Investment property
x The present economic resource is x The present economic resource is
- the right to sell the inventory - the right to direct the use of the property
- where the right has the potential to produce economic benefits through the inflow - where the right has the potential to produce economic benefits through the inflow
of cash, or another economic resource, when the inventory is sold of cash when the lease rentals are paid
x It is controlled through legal ownership, as the entity purchased the inventory x It is controlled through legal ownership
x The past event is the purchasing, of the inventory, whereby the entity gained control. x The past event is the purchasing and obtaining control of the property.
(ii) Trade receivable
x The present economic resource is 5.3 Liability definition (CF 4.26-4.47)
- the right to collect the amount owed
5.3.1 Overview
- where this right has the potential to produce economic benefits through receiving cash
x It is controlled through a legal contract of sale
The new 2018 CF has introduced a new liability definition. A comparison of the new liability definition
x The past event is the performance of our obligations (e.g. delivering the goods). with the old liability definition, per the previous 2010 CF, is shown below
(iii) Cash in a savings account
x The present economic resource is OLD 2010 CF NEW 2018 CF
- the right to receive the cash from the bank A liability was defined as: A liability is defined as:
- where the right has the potential to produce economic benefits through the use of x Present obligation of the entity x A present obligation of the entity Note 1
the cash (e.g. the cash could be used on its own, or with other resources, to x As a result of past events x To transfer an economic resource
produce inventory or enhance plant and equipment etc) x From which future economic benefits are x As a result of past events See CF 4.26
expected to flow from the entity Note 1: A present obligation is a:
x It is controlled through a legal contract with the bank
x The past event is the acceptance of the contract with the bank and the depositing of x a duty or responsibility that an entity
the cash with the bank. x has no practical ability to avoid See CF 4.29

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For a liability to exist the entity must have a present obligation to transfer an economic resource as a
result of a past event. The ‘present obligation’ is a duty or responsibility that the entity has no
practical ability of avoiding. See CF 4.26 & .29
The most significant change arising from the new liability definition is possibly the clarification of the
meaning of ‘present obligation’. The CF now emphasizes that an obligation exists if the entity has a
duty or responsibility that it has no practical ability of avoiding. In other words, if the only way to avoid
an obligation is, for example, to liquidate or cease trading, then we conclude that we do not have a
practical way of avoiding it and must accept that we have an obligation. This is in contrast with the
previous concept of an obligation, where we would conclude that an obligation did not exist if there
was, in theory, a way we could avoid it, even though we might know that avoiding it in that way (e.g.
through ceasing trade) would not be practical (See IAS 37 Provisions and contingent liabilities et al).
According to the liability definition, the obligation must involve a transfer of economic resources. The
economic resource can be a variety of things, such as the rights to cash, goods or services.
Furthermore, in terms of the liability definition, the obligation is only considered to be a present
obligation (i.e. an obligation that ‘presently’ exists as at reporting date) if there is a past event (i.e. an
event that has occurred on or before reporting date). However, unlike the asset definition, the liability
definition provides criteria that must be met before we conclude that a past event has occurred. We
could describe these criteria as the ‘cause and effect’ criteria. These criteria are:
x the entity must have either obtained a benefit or taken an action (i.e. the entity has received
something or done something – the cause), and that
x as a result, the entity may have to transfer an economic resource that it would otherwise not
have had to transfer (i.e. as a result, the entity may have to give up an asset – the effect).
5.3.2 Liability definition discussed in more detail
Let us know look at the definition in more detail.
x There must be a present obligation
An obligation exists if the entity has
 a duty or responsibility that it has
 no practical ability of avoiding. See CF 4.28-29
Obligations always involve a duty or responsibility that is owed to a third party, though it is not
necessary to know who this party is.
The obligation could be a legal obligation, constructive obligation or even conditional.
x Legal obligations arise if the entity cannot practically avoid a duty or responsibility to another
party because that other party can legally enforce the entity’s duty or responsibility to them
(e.g. if we receive cash from a customer for the delivery of inventory, we are legally bound to
perform our duty to either deliver the inventory or return the cash).
x Constructive obligations arise if an entity has no practical ability to act inconsistently with its
own ‘customary practices, published policies or specific statements’ (e.g. if we cause
environmental damage and have a published policy of rehabilitating any areas that we may
damage, then we would have a constructive obligation to rehabilitate the environment).
x Conditional obligations arise if an entity’s duty or responsibility to transfer an economic
resource is conditional on the entity’s own future actions, but where the entity has no
practical ability of avoiding these future actions. Sometimes, the duty or responsibility can
only be avoided by the entity ceasing trading or liquidating, in which case simply preparing
financial statements on a going concern basis is sufficient to conclude that the conditional
obligation is a present obligation. See CF 4.31-32
x The obligation must have the potential to require a transfer of an economic resource
The obligation must have the potential to require the entity to transfer an economic resource.
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Notice that the term ‘economic resource’ is part of the definition of an ‘asset’ (a right that has the
potential to produce economic benefits). So basically, the liability definition is saying that, for us
to conclude that there is a liability, we will have to prove that the obligation has the potential to
require the entity to transfer an asset. For example:
 in the case of ‘accounts payable’, there is an obligation to transfer cash;
 in the case of ‘income received in advance’, there is an obligation to deliver inventory or
services … or even just to return the cash (remember that, in both examples, we are
referring to the transfer of the rights inherent in these ‘objects’).
The potential transfer of economic resources does not have to be certain or even probable – the
potential could even be just a remote possibility. A low probability of a transfer of resources
being required is not a consideration when deciding if the item meets the liability definition.
Instead, a low probability of a transfer of resources, will be considered when deciding:
x whether to recognise the liability (if information about this liability would still be considered
useful by our users, despite the low probability of a transfer of resources being required, we
might still recognise it: see section 6), and
x how it is to be measured (see section 7).
This is the same principle that we apply when identifying whether an item meets the asset
definition (see section 5.2).
x This obligation must arise as a result of a past event
For an obligation to be a present obligation, it must have arisen from a past event. In the case of
the liability definition (unlike the asset definition), there are criteria that need to be met before we
can conclude that there has been a past event:
x The entity must have already either:
 obtained an economic benefit, or
 taken an action, and
x As a result, the entity will, or may, have to transfer an economic resource* that it would
otherwise not have had to transfer.
*: As explained previously, the term ‘economic resource’ refers to ‘a right that has the potential
to produce economic benefits’ (i.e. it is part of the definition of an asset). Therefore, for us to
conclude that a past event has occurred, the entity must have entered into an exchange
contract whereby it obtained some kind of benefit, or took some kind of action, and as a
result, the entity may potentially have to transfer an ‘asset’.
Consider the following examples:
x An entity receives, before reporting date, cash in advance from a customer for the delivery
of inventory (i.e. ‘income received in advance’).
 The entity has already obtained an economic benefit: it has received the cash.
 As a result of the cash receipt, the entity will have to transfer an economic resource that
it would otherwise not have had to transfer: the entity has to either deliver the inventory
to the customer (i.e. transferring the rights inherent in the inventory to the customer) or
refund the cash to the customer (i.e. transferring the rights inherent in the cash).
x An entity, before reporting date, causes damage to the environment by leaking poison into a
river (e.g. ‘provision for rehabilitation’):
 The entity has already taken an action (leaking poison into the river).
 As a result of this action, the entity will, or may, have to transfer an economic resource
that it would otherwise not have had to transfer: the entity may now be obliged to
rehabilitate the environment. If so, the entity will or may be required to rehabilitate the
area, which will result in an outflow of economic resources: the transfer of economic
resources would typically be in the form of cash. For example, if it chose to employ the
services of a rehabilitation agency to perform the rehabilitation work on behalf of the
entity, the entity would have to pay cash to the agency for the rehabilitation work done.
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Example 3 Liability – rent payable c) Bank overdraft

Beta rents office space from a landlord, at C10 000 per month. It uses this space to run a x The entity has a present obligation, because:
business selling advice. At 31 December 20X4, it still owes the rent for December 20X4. - the entity has the duty to pay the bank
- the entity has no practical ability of avoiding the duty due to the legal nature of
Required: From Beta’s perspective, prove that the payable is a liability at 31 December 20X4. overdrafts/credit granted
x The obligation has the potential to result in a transfer of an economic resource: in this
Solution 3: Liability – rent payable
case the obligation requires the entity to transfer cash
At 31 December 20X4, Beta has not yet paid the December 20X4 rent and thus has a liability: x There is a past event because the potential transfer of economic resources is as a result
x There is a present obligation of the entity having either obtained an economic benefit or taken an action (i.e. there is
x the entity has a duty to pay the landlord monthly rental; and cause and effect): in this case, the potential transfer of economic resources is because
x the entity has no practical ability of avoiding this duty since this duty is legally enforceable the entity has obtained an economic benefit by using the overdraft facility.
through a rental agreement.
x The obligation involves transferring an economic resource: 5.4 Equity definition (CF 4.63–4.67)
The obligation requires a transfer of economic resources, by way of a cash payment to the landlord. Equity is:
x The obligation is as a result of a past event/s x the residual interest in the assets of the entity
x the entity has already obtained the benefits since it was able to use the office space x after deducting all its liabilities. See CF 4.63
during December 20X4, and
The equity definition in the 2018 CF is the same definition that existed in the 2010 CF.
x as a result, Beta will be required to transfer an economic resource, in the form of cash (i.e.
the right to use the cash will be transferred from Beta to the landlord). When we look at an entity’s financial position, we are comparing its total assets with its total liabilities.
If the total assets exceed the total liabilities (i.e. it has net assets), the entity has equity (positive
Example 4: Liability – various equity). If the total liabilities exceed its assets (i.e. it has net liabilities), the financial position is very
The accountant is concerned that the new liability definition in the CF will result in certain unhealthy, and we say it has negative equity. The equity is often called the entity’s ‘net wealth’.
items, which are currently considered to be liabilities, no longer meeting the definition of a
The entity’s total equity, total assets and total liabilities all appear in the statement of financial
liability, and vice versa.
position, using the following two headings: ‘assets’ and ‘equity and liabilities’.
Required: Using the ‘new’ liability definition per the 2018 CF, briefly prove that the following items
Entity name
are liabilities: Statement of financial position 20X2 20X1
a) Trade payables As at 31 December 20X2 C’000’s C’000’s
b) Provision for legal costs due to the entity taking a competitor to court over a patent
infringement. ASSETS 140 000 90 000
c) Bank overdraft. EQUITY AND LIABILITIES 140 000 90 000
Equity 100 000 70 000
Solution 4: Liability – various Liabilities 40 000 20 000

a) Trade payables
x The entity has a present obligation, because it: In the above statement of financial position, the entity’s equity was C70 000 at the end of
- has the duty to pay the pay the supplier (i.e. the creditor) 20X1 and this grew to C100 000 at the end of 20X2. This total equity, in terms of the equity
- has no practical ability of avoiding the duty due to the legal contract of purchase. definition, is:
x The obligation has the potential to result in a transfer of an economic resource: in this x End of 20X1 = Assets: 90 000 – Liabilities: 20 000 = Equity: C70 000
case the obligation requires the entity to transfer cash x End of 20X2 = Assets: 140 000 – Liabilities: 40 000 = Equity: C100 000
x There is a past event because the potential transfer of economic resources is as a result
Although this equity represents the entity’s ‘net assets’, it also represents the total of the
of the entity having either obtained an economic benefit or taken an action (i.e. there is
entity’s ‘issued share capital and reserves’. Using the same example above, let us assume
cause and effect): in this case, the entity has already obtained the benefit by having
that 20X1 was its first year of operations and that, during this year, the entity issued ordinary
purchased and taken possession of the inventory.
share capital of C50 000 and that it earned profits of C20 000 (these profits are included as a
b) Provision for legal costs retained earnings reserve within equity). During 20X2, the entity did not issue any further
x The entity has a present obligation, because: shares and made a further profit of C30 000. Thus, the total equity, at the end of each year
- the entity has the duty to pay the contracting lawyer/law firm will be broken down, in the statement of financial position, as follows:
- the entity has no practical ability of avoiding the duty due to the legal contract (e.g. the Entity name
entity effectively enters into a service agreement with the lawyers who agree to provide Statement of financial position 20X2 20X1
legal advice or services) As at 31 December 20X2 C’000’s C’000’s
x The obligation has the potential to result in a transfer of an economic resource: in this ASSETS 140 000 90 000
case the obligation requires the entity to transfer cash
EQUITY AND LIABILITIES 140 000 90 000
x There is a past event because the potential transfer of economic resources is as a result Equity 100 000 70 000
of the entity having either obtained an economic benefit or taken an action (i.e. there is x Issued share capital 50 000 50 000
cause and effect): in this case, the potential transfer of resources is because the entity has x Retained earnings (20X2: O/b 20 000 + profit: 30 000) 50 000 20 000
taken an action by instituting legal proceedings against a competitor and/ or engaging the Liabilities 40 000 20 000
services of a lawyer.

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Another way of looking at the entity’s financial position, is that the entity’s assets (economic resources), OLD 2010 CF NEW 2018 CF
have been funded: Expenses were defined as: Expenses are defined as:
x through liabilities (obligations) and x Decreases in economic benefits x Decreases in assets, or
x through equity (which does not involve any obligations). x During the accounting period x Increases in liabilities
x In the form of x Other than those relating to distributions to
To illustrate this point, let us look at 20X1 again. Let us assume that the entity had raised a loan of  outflows or depletions of assets or holders of equity claims.
C20 000, on the last day of 20X1. This is reflected on the statement of financial position as the total  incurrences of liabilities See CF 4.69

liabilities of C20 000. The receipt of the funds from this loan, will have led to the recognition of: x That result in decreases in equity,
x an asset, due to the receipt of the loan increasing the entity’s economic resource (the cash in its x Other than those relating to distributions to
equity participants. See CF 4.25 (b)
bank account), and also
x a liability, due to the fact that there will be a legal loan agreement, which means that the entity has There are no significant changes in the essence of these definitions other than now referring to ‘holders
an obligation to repay this cash. of equity claims’ instead of ‘equity participants. The new definitions have simply become a lot clearer:
x Income arises from increases in equity (increases in assets or decreases in liabilities) that do not
Since both the asset and the liability increase, we say that there is no equity involved in this transaction
result from contributions from holders of equity claims.
(debit bank (asset) with C20 000, and credit loan liability (liability) with C20 000).
x Expenses arises from decreases in equity (decreases in assets or increases in liabilities) that do not
By contrast, the share capital of C50 000 that was issued during 20X1, does involve equity. This is result from distributions to holders of equity claims.
because entities have no obligation to repay cash that is received in exchange for ordinary shares. Since
this transaction increases the entity’s economic resources (cash in bank) but does not increase its The logic behind these definitions is best explained by example.
liabilities, we say that the transaction has resulted in the recognition of equity (debit bank (asset) with
C50 000, and credit ordinary share capital (equity) with C50 000) Worked example 4: Income definition
If an entity receives C100 cash (an asset), but this transaction does not simultaneously increase liabilities (or
A transaction involving the issue of ordinary shares, is called an equity claim. These ordinary decrease another asset), then, by definition, it has increased equity (Equity = A – L = 100 – 0 = 100).
shareholders (who have contributed C50 000 to the entity) are referred to as ‘holders of equity claims’.
If this increase in equity represents a contribution from a holder of an equity claim (e.g. if the cash was from the
The entity’s receipt of cash from the issue of ordinary shares is thus referred to as a ‘contribution from
issue of shares to ordinary shareholders), then it is excluded from the definition of income and would be
holders of equity claims’ and dividends paid to them are called ‘distributions to holders of equity claims’.
journalised as follows (see section 5.4)
Debit Credit
An equity claim is not the same as equity: an equity claim is ‘a claim on the residual interest in the Bank (Asset) 100
entity’s assets after deducting its liabilities’ whereas equity is the ‘residual interest in the assets after Issued share capital (Equity) 100
deducting its liabilities’. The term ‘equity claims’ is also described as ‘the claims against the entity that do Receipt of proceeds from a share issue (equity – not income!)
not meet the definition of a liability’ (i.e. a claim that does not involve an obligation). To illustrate the
However, if this increase in equity does not represent a contribution from a holder of an equity claim, then the
difference, look at the above example:… At the end of 20X1, we have economic resources (assets) of
transaction meets the definition of income. Examples of income include sales, interest earned or rent earned. If
C90 000, of which C20 000 will eventually be transferred to third parties due to the obligations (liabilities).
the income was rent income, the journal would be as follows:
x Thus, the equity is C70 000 (Equity = Assets: 90 000 – Liabilities: 20 000)
Debit Credit
x However, the equity claim at 31 December, based on the share issue transaction is C50 000.
Bank (Asset) 100
Rent income (Income) 100
Different classes of equity claims are possible, such as ordinary and preference shares, depending on Receipt of proceeds from a sale (income!)
the rights attached to them (e.g. rights to dividends, profit-sharing and liquidation rights).
Worked example 5: Expense definition
An entity can also generate economic resources by making its own profits. These profits are also
If an entity pays C100 in cash (an asset), but this transaction does not simultaneously decrease liabilities (or
part of total equity. Whether we have made a profit depends on the definitions of income and
increase another asset), then, by definition, it has decreased equity (Equity = A – L = –100 – 0 = -100).
expenses (profit = income - expenses). This is explained in the next section.
If this decrease in equity represents a ‘distribution to a holder of an equity claim’ (e.g. if the cash outflow is a
5.5 Income and expense definitions (CF 4.63–4.67) dividend payment), then it is excluded from the expense definition and is journalised as follows (see section 5.4)
Debit Credit
The new 2018 CF has introduced a new income and expense definition. A comparison of these new
Dividends declared (Equity distribution) xxx
definitions with the old definitions, per the previous 2010 CF, is shown below. Bank xxx
Payment of a dividend (equity distribution – not expense!)
OLD 2010 CF NEW 2018 CF
Income was defined as: Income is defined as: However, if this decrease in equity does not represent a ‘distribution to a holder of an equity claim’, then the
x Increases in economic benefits x Increases in assets, or transaction meets the definition of an expense. Examples of expenses include cost of sales, interest incurred or
x During the accounting period x Decreases in liabilities rent incurred. If the expense was a rent expense, the journal is as follows:
x In the form of x Other than those relating to contributions Debit Credit
 inflows or enhancements of assets or from holders of equity claims. Rent expense (Expense) 100
 decreases of liabilities See CF 4.68
Bank 100
x That result in increases in equity, Receipt of proceeds from a sale (income!)
x Other than those relating to contributions from
equity participants. See CF 4.25 (a)

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Example 5: Expense – arising from a payable
This example follows on from example 3: Beta rents office space from a landlord, at
C10 000 pm. It uses this space to run a business selling financial advice. At
31 December 20X4, it still owes the rent for December 20X4.
Required: Prove that Beta’s payable results in an expense at 31 December 20X4.
Solution 5: Expense – arising from a payable
Solution 3 proved that a liability exists at 31 December 20X4 (since Beta had not yet paid the
December rent on this date). This liability also leads to the existence of an expense:
x There is an increase in liabilities: The payable increases Beta’s liabilities
x The increase in liabilities results in a decrease in equity: The transaction increased the
liabilities but did not change the assets, and thus equity does decrease.
x The decrease in equity is not a distribution to a holder of an equity claim: This payable
involves a landlord and not a holder of an equity claim (e.g. ordinary shareholder) and
thus is not a distribution to a holder of an equity claim.
The journal would be: debit rent expense and credit rent payable liability.
Remember, income and expenses are accumulated together to reflect the profit or loss for the
period (although some income and expenses are excluded from ‘profit or loss’ and are
included in ‘other comprehensive income’ instead – see chapter 3 for more detail).
This profit or loss will then be transferred to retained earnings. Retained earnings is a reserve
account within equity (i.e. the total equity on the statement of financial position would reflect
the total of the ‘issued share capital’ plus the ‘reserves’ (see section 5.4).
Worked example 6: Income and expense – part of equity reserves
An entity begins operations in 20X1. During this year, it earns one type of income (sales income: C85 000)
and incurs one type of expense (cost of sales expense: C65 000). This means that the entity makes a
profit of C20 000 (income 85 000 – expenses: 65 000), which will then be transferred to retained
earnings. Since this was the first year of operations, it means that the retained earnings opening
balance will be nil, and thus the closing retained earnings at the end of 20X1 will be C20 000.
The closing entries and transfer will appear as follows:
Debit
Sales (Income) 85 000
Cost of sales (Expense)
Profit or loss (Closing account)
Closing entry: income and expenses closed off to profit or loss
Profit or loss 20 000
Retained earnings
Profit or loss transferred to retained earnings (equity reserve)
6. Recognition and Derecognition (CF: Chapter 5)
Recognise = Journalise
6.1 Recognition (CF 5.1 – 5.25)
An element may only be
recognised if it meets both the:
6.1.1 The meaning of the term ‘recognition’
x Element definitions; and
x Recognition criteria.
To recognise an item involves the process of:
x capturing in the financial statements, (specifically either the statement of financial position
or statement of financial performance),
x an item that meets the definition of an element
x in such a way that:
 it is depicted in both words and amount (either alone or in aggregation with other
items); and that
 this amount is included in one or more totals in the specific financial statement
(position or performance). See CF 5.1
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Since financial statements (statement of position and performance) are essentially a summary of
the balances in the ledger, and since the ledger balances result from the various journals that are
processed, the question of whether to recognise an element essentially means whether to actually
process the journal entry to record the effects of the transaction or event.
Worked example 7: Recognising an asset and a liability
A transaction involving the credit purchase of a machine involves two elements: an asset
(machine) and a liability (payable). If the machine meets the definition of an asset and the
recognition criteria and if the payable meets the definition of a liability and the recognition criteria, the
elements must be recognised.
To recognise these elements, a journal entry must be processed (debit the asset and credit the liability).
Once this journal has been posted to the ledger, the two elements involved in the transaction (asset and
liability) will appear in the ledger, trial balance and ultimately the financial statements (in this case, both
elements appear in the statement of financial position).
6.1.2 Recognition criteria (CF 5.6-5.25)
6.1.2.1 Overview
Before recognising a transaction or event, we first identify the elements and check they meet the
definitions thereof (see section 5), and then secondly, we ensure they meet the recognition criteria.
In this regard, the new 2018 CF has introduced new recognition criteria. A comparison of the new
recognition criteria with the recognition criteria per the previous 2010 CF, is shown below.
OLD 2010 CF NEW 2018 CF
Recognition criteria were: Recognition criteria are:
At item that meets the definition of an element Assets and liabilities, and any resulting income,
should be recognised if: expenses or changes in equity, must only be
x The future economic benefits are probable recognised if the user would find this information
x The item has a cost or value that is reliably useful, i.e. we only recognise the elements if it
means we are providing information that is:
measurable.
x relevant; and
x a faithful representation. See CF 5.7
Meeting the recognition criteria means making sure that, by recognising an element, we will be
Credit
providing the user with useful information, in other words:
65 000 x relevant information about the asset or liability, and any resulting income, expenses or
20 000 changes in equity; and a
x faithful representation of the asset or liability, and any resulting income, expenses or changes
in equity. See CF 5.7
20 000
We must also consider the effects of the cost of recognising the element versus the benefits of
providing the information (the benefits must outweigh the costs).
The most significant change from the 2010 CF is that we no longer have to achieve what was
referred to as a ‘probability’ threshold or ‘reliable measure’ threshold. Instead, we now focus on
whether the information will be useful.
The recognition of elements is thus based on achieving the two fundamental qualitative
characteristics: relevance and faithful representation (see section 4.2).
The issues of uncertainty that were ignored when we assessed whether an item met the definition
of an element, are now taken into account when we decide whether that element should be
recognised. For example: we ignored, in the case of an asset, the fact that the potential to produce
economic benefits may be very remote (often referred to as ‘outcome uncertainty’). The
uncertainties that we consider when deciding whether an element should be recognised, can be
summarised as follows:
x Outcome uncertainty
x Measurement uncertainty
x Existence uncertainty.
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6.1.2.2 Relevance
Recognition criteria:
The relevance of information is affected by: The information recognised
must be
x existence uncertainty (e.g. the existence of an x relevant; and
obligation may be the content of a legal dispute); and x a faithful representation.
See CF 5.7
x outcome uncertainty (e.g. we may be certain the
element exists, but the probability of the flow of economic benefits may be low or even remote
– outcome uncertainty relates to the amount or timing of the flow of economic benefits).
Both types of uncertainty, (i.e. where we may be unsure of whether the element exists, or if it
does, whether there will be a flow of economic benefits), may result in us concluding that the
user would find the information irrelevant.
6.1.2.3 Faithful representation
A faithful representation of the information is affected by:
x measurement uncertainty.
Measurement uncertainty arises when the amounts presented in the financial statements cannot
be observed directly and must be estimated. However, most amounts in the financial statements
actually involve some degree of estimation and this does not mean that the information is not
useful. What is important is that, when we recognise information, the level of measurement
uncertainty must be considered to be acceptable.
6.1.2.4 The trade-off between relevance and faithful representation
The level of measurement uncertainty not only affects whether we believe the information is a
faithful representation of the transaction or event, but it has a knock-on effect on relevance. For
example, it can happen that the most relevant information that a user would want, has an
unacceptable level of measurement uncertainty and thus we conclude that it would be better to
provide the user with the information that is slightly less relevant but a more faithful representation.
An example of this might be land (an asset), where the user may ideally want to see the fair value
(most relevant information), but where the measurement uncertainty involved in measuring fair
value might be so high that we conclude that information about the fair value would not be a
faithful representation of the land. In this case, we might conclude that we will simply have to
provide the user with information about the land’s cost instead. In this case, although information
about the land’s cost is less relevant to the user, because it is the only information that is able to
be measured with an acceptable level of measurement uncertainty, it is the only information that is
a faithful representation of the land. See section 4.2 for more examples.
6.1.3 When an element is not to be recognised’
Elements that do not meet the relevant definitions and recognition criteria in full may not be
recognised in the financial statements. Information about them may, however, still be
considered ‘useful’ to the user, in which case they should still be disclosed in the notes.
If information is not recognised, it may cause a recognition inconsistency (also called an
‘accounting mismatch’). If this occurs, explanatory information must be included in the notes to
explain the uncertainties that existed, which prevented it from being recognised. See CF 5.23 and .25
An element that fails to be recognised because the recognition criteria are not met may be
recognised in a subsequent period if the recognition criteria are then subsequently met.
6.2 Derecognition (CF 5.26 – 5.33)
Derecognition refers to the ‘removal of all or part of a recognised asset or liability from the
statement of financial position’. This normally happens when the asset or liability subsequently
fails to meet the relevant definition.
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In the case of an asset, this normally happens ‘when the entity loses control’ over the asset
(or part thereof). In the case of a liability, this normally happens ‘when the entity no longer has
a present obligation for all or part of the recognised liability’. See CF 5.26
If part of the asset or liability remains, we must take care to faithfully represent both:
x The assets and liabilities that remain; and
x The change in the assets and liabilities that result from the transaction or event that
caused the derecognition. See CF 5.27
7. Measurement (CF: Chapter 6)
7.1 Overview
Financial statements present information about the entity’s financial position and performance:
x The financial position reflects the elements: assets, liabilities and equity;
x The financial performance reflects the elements: income and expenses.
All five elements are ‘quantified in monetary terms’. To quantify an element means to
measure the element. There are many measurement bases possible. In order to assist in this
process, the CF has introduced a new section on measurement, which:
x Describes various different measurement bases; and
x Provides factors to consider when selecting a measurement basis.
The CF identifies two main categories of measurement bases:
x the historical cost (i.e. the price of the transaction that gave rise to the recognition of the
element) and
x the current value (e.g. fair value, value in use and current cost).
Our focus when choosing a measurement basis is to ensure that the information provided will
be useful (i.e. the information must be relevant and a faithful representation). However, other
factors are also considered (see section 7.3).
The choice between the various measurement bases will require significant judgement.
It should be noted that this section in the CF is mainly used by the IASB: the IASB will use
this section when it develops IFRSs and decides which measurement bases are most suitable
for those IFRSs. Normally IFRSs are fairly prescriptive as to which measurement basis to
use, and thus the preparer need not always consider this section of the CF that deals with
measurement. However, if an IFRS allows preparers of financial statements to choose
between measurement bases (e.g. IAS 40 Investment properties allows preparers to choose
between the cost model and the fair value model), having guidance in the CF that provides
explanations about the meaning and purpose of the different measurement bases and what
factors to consider in choosing between them, is very helpful.
7.2 Different measurement bases
7.2.1 Overview
The CF describes two measurement bases but emphasizes that it does not prefer one over
the other – both are useful measurements. However, although both measurement bases can
provide predictive and confirmatory value, depending on the particular situation, one of these
measurement bases may provide more useful information than the other.
The two main measurement bases are historical cost and current value
The CF gives three examples of measurement bases that use the current value approach:
fair value, value in use and current cost.
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The ‘historical cost’ and ‘current cost’ (the latter is a measurement basis using the current value
approach) both reflect what is referred as an ‘entry price’ (the price to acquire the asset or liability).
x The ‘historical cost’ is a measurement that is based on the actual acquisition price on the historic
transaction date (e.g. in the case of an asset, it is a measurement that is based on the actual
historic price that was incurred to acquire that asset), whereas
x The ‘current cost’ is a measurement that is based on the theoretical acquisition price on the
current measurement date (e.g. in the case of an asset, it is a measurement that reflects how
much it would cost to acquire, on measurement date, an equivalent asset based on the current
age and condition of the entity’s asset – in other words, it is the price to acquire an equivalent
second-hand asset at measurement date).
By contrast, the ‘fair value’ and ‘value in use’ both reflect what is referred to as an ‘exit price’.
Measurement base Entry price/ exit price
x Historical cost Entry price
x Current value
 Current cost Entry price
 Fair value Exit price
 Value in use Exit price
Although the CF refers to the above measurement bases, these are not an exhaustive list. In
this regard, we must remember that, the measurement of assets and liabilities are generally
dictated by the requirements set out in the specific IFRSs, which often reflect a combination of
the ideas underlying the measurement bases listed in the CF. For example:
x Assets purchased with the intention of resale are measured in terms of IAS 2 Inventories:
IAS 2 requires inventories to be initially measured at ‘cost’ and subsequently measured at
the ‘lower of cost or net realisable value’.
x Assets purchased to be used over more than one period are measured in terms of
IAS 16 Property, Plant and Equipment:
IAS 16 requires this asset to be initially measured at cost and subsequently measured
using either its historical cost or fair value as the basis for the various calculations (e.g.
depreciation), and where its fair value could be based on a discounted future cash flow
technique (i.e. present value), or an active market (i.e. current cost).
7.2.2 Historical cost
As mentioned earlier, the historical cost is based on ‘the price of the transaction or other
event that gave rise to the asset or liability’. See CF 6.24
The historical cost is useful in the sense that, if the transaction was ‘a recent transaction on
market terms’, it will typically reflect:
x in the case of an asset, the minimum economic benefits that the entity expects to recover
(i.e. the economic benefits that the entity expects to flow into the entity will be at least the
carrying amount of the asset); and
x in the case of a liability, the maximum economic benefits that the entity expects to transfer
out in order to settle the liability. See CF 6.25
The measurement of an asset at historical cost often includes:
x transaction costs, and
x reductions in the cost to reflect consumption (depreciation and amortisation) and
impairments. See CF 6.26
Examples of assets and liabilities measured using the historical cost approach include:
x property, plant and equipment measured under the cost model in terms of IAS 16 (cost
less subsequent depreciation and impairment losses),
x inventory measured at cost (in terms of IAS 2), as well as
x financial liabilities measured by applying the amortised cost model (in terms of IFRS 9).
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7.2.3 Current value
A measurement that is based on current values reflects the ‘current conditions’ at
measurement date. This differs from the historical cost approach, which derives its value from
the original transaction that gave rise to the item being measured: the current value approach
derives its value from circumstances and conditions that exist on measurement date.
The CF refers to three different methods that fall under the current value approach. These are
the fair value method, the value in use and fulfilment value method, and the current cost
method. These are described below:
x Fair value is defined in IFRS 13 as the price that would be received to sell an asset, or
paid to transfer a liability, in an orderly transaction between market participants at the
measurement date. See CF 6.12
Examples of assets or liabilities that could possibly be measured at fair value include:
 investment property under the ‘fair value model’,
 property plant and equipment measured under the ‘revaluation model’, and
 certain financial assets and financial liabilities held for trading measured at ‘fair value
through profit or loss’.
x The value in use of an asset is the present value of the cash flows, or other economic benefits
that an entity expects to derive from the use of an asset and from its ultimate disposal. See CF 6.17
The fulfilment value of a liability is the present value of the cash, or other economic resources,
that an entity expects to be obliged to transfer as it fulfils a liability (i.e. ‘fulfilment value’ is the
equivalent of the ‘value in use’, but from the perspective of a liability). See CF 6.17
Those amounts of cash, or other economic resources, include not only the amounts to be
transferred to the liability counterparty, but also the amounts that the entity expects to be obliged
to transfer to other parties to enable it to fulfil the liability.
Value in use is used to test certain assets for impairment.
Examples of assets that are tested for impairment in this way include, for example:
 Property, plant and equipment
 Intangible assets
x The current cost of an asset is the cost of an equivalent asset at the measurement date,
comprising the consideration that would be paid at the measurement date, plus the transaction
costs that would be incurred at that date. ‘Equivalent’ means that, if our asset is 3 years old, we
would use the current cost of a 3-year-old asset – not the current cost of a new asset. See CF 6.21
The current cost of a liability is the consideration that would be received for an equivalent liability
at measurement date, minus the transaction costs that would be incurred at that date. See CF 6.21
Example: An entity acquired a plant three years ago for C200. The current price that the
entity would have to pay to buy a new plant is C250, whereas a three-year-old plant is
about 40% of the new price. Thus, the current cost is C100 (C250 x 40%).
7.3 Factors to consider when selecting a measurement basis
7.3.1 Overview
When selecting a measurement basis, we must keep in mind the ultimate objective of
providing useful information. Thus, the measurement base must provide information that is:
x Relevant; and a
x Faithful representation of the substance of the transaction.
The choice between the various measurement bases will require significant judgement. The
CF states that when applying this judgement, we must ‘consider the nature of the information
that the choice of measurement basis will produce in both the statement of financial position
and the statement of financial performance’. See CF 6.23 & .43
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7.3.2 Relevance
8. Unit of account (CF 4.48 – 4.55)
The CF states that ‘the characteristics of the asset or liability’, and how it ‘contributes to future
cash flows’ are two of the factors that can affect whether a particular measurement basis The definition of ‘unit of account’ (see pop-up) refers to ‘rights’
provides relevant information. See CF 6.49 and ‘obligations.’. If you recall, these two words form the basis of Unit of account is
the asset and liability definitions: defined as:
For example, if an asset is sensitive to market factors, fair value might provide more relevant x An asset is a present economic resource controlled by the x The right, or group of rights,
information than historical cost. However, depending on the nature of the entity’s business entity as a result of past events. An economic resource is a x The obligation, or group of
activities, and thus how the asset is expected to contribute to future cash flows, fair value right that has the potential to produce economic benefits. obligations, or
x The group of rights and
might not provide relevant information. This could be the case if the entity holds the asset x A liability is a present obligation of the entity to transfer an obligations
solely for use or to collect contractual cash flows rather than for sale, in which case a economic resource as a result of past events. In order for a x To which recognition criteria
measurement based on amortised cost might be more relevant. and measurement concepts
liability to exist, three criteria must be met, the first of which are applied CF 4.48
is that an obligation must exist.
7.3.3 Faithful representation
Therefore, units of account relate to those two elements and their recognition and
The CF explains that, although information that is a ‘perfectly faithful representation is free measurement in terms of IFRS.
from error’, we are not aiming at a ‘perfectly faithful representation’. It emphasizes that even a
high level of measurement uncertainty does not mean a particular measurement basis is not a A unit of account is selected for an asset or liability when considering how recognition criteria and
faithful representation. However, the most important aspect is that we are striking a balance measurement concepts will apply to that asset or liability and to the related income and expenses. In
between relevance and faithful representation. See CF 6.59-60 some circumstances, it may be appropriate to select one unit of account for recognition and a
different unit of account for measurement. For example, contracts may sometimes be recognised
It should be noted, however, that if an asset and liability are ‘related in some way’, that individually but measured as part of a portfolio of contracts.
measuring the assets and liabilities using different measurement bases may result in a
‘measurement inconsistency’ (also called an ‘accounting mismatch’) that results in the As explained earlier in the chapter, the objective of general-purpose financial reporting is to
information not being a faithful representation. See CF 6.58 provide financial information about the reporting entity that is useful (see section 2.1).
Keeping that objective in mind, a unit of account is chosen, with the following implied:
7.3.4 Other considerations x the information provided about the asset or liability and about any related income and
expenses must be relevant; and
In addition to aiming to choose a measurement basis that produces relevant information that
x the information provided about the asset or liability and about any related income and
is also a faithful representation, when choosing the measurement basis, we should also be
expenses must faithfully represent the substance of the transaction or other event from
striving, to the extent possible, to achieve information that is:
which they have arisen. See CF 4.51
x Comparable
x Verifiable The recognition criteria of an asset or liability are similarly phrased, with really, the substance
x Timely. See CF6.45 being equivalent to the above statement. With that in mind, we can further join the dots in this
long document and see that, at the heart of it, are some very basic, but fundamental
A further important consideration is that although we may use one particular measurement principles. If those principles can be grasped early, understanding the Conceptual
basis to measure an asset or liability in the statement of financial position and use another Framework, and understanding accounting, becomes much easier.
different measurement basis to measure the related income or expenses in the statement of
financial performance, it cautions us to remember that information may be more useful if the
same measurement basis is used in both statements. This is because using different 9. Presentation and Disclosure Principles (CF: Chapter 7)
measurement bases may cause an ‘accounting mismatch’. See CF 6.58
9.1 Recognition versus presentation and disclosure
Similarly, when choosing a measurement basis, one should also consider both the initial
measurement and subsequent measurement. See CF 6.48 As mentioned earlier, the term ‘recognition’ means the actual recording (journalising) of a
transaction or event. Once recorded, the element will be included in the journals, trial balance
Uncertainty also feeds into the measurement basis chosen. There are three identified and then channelled into
uncertainties: measurement uncertainty, outcome uncertainty and existence uncertainty.
Outcome uncertainty and existence uncertainty may or may not contribute to measurement x one of the financial statements presented on the accrual basis:
uncertainty. For example, consider an investment in shares: if the share price is quoted within  statement of comprehensive income, Presentation &
an active market, it means that there is no measurement uncertainty at all. However, there is  statement of changes in equity, or disclosure refers to the
still a level of outcome uncertainty since there is no way of knowing what cash inflow will  statement of financial position; as well as level of detail in the
information given about elements
eventually be achieved through this asset. See CF 6.61-62 x the financial statement presented on the cash basis: that are:
 statement of cash flows. x Recognised;
When selecting a measurement basis, there is no single factor that is considered more x Not recognised but still relevant.
important than another. The relative importance of each factor will depend on facts and The presentation of financial statements (e.g. how they are structured and the level of detail in
circumstances. Professional judgement will be needed. See CF6.44 terms of line-items presented) is dictated by IAS 1 Presentation of financial statements and is
explained in chapter 3.

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The term ‘disclosure’ typically refers to extra detail provided in the notes to the financial statements.
Disclosure refers to giving detail about specific transactions or events that are either:
x already recognised in the financial statements; or
x not recognised in the financial statements but are considered to be relevant to the users thereof.
Some items that are recognised may require further disclosure. Where this disclosure
involves a lot of detail, this is normally given in the notes to the financial statements.
Other items that are recognised may not need to be separately presented and/ or disclosed. For
example, the purchase of a computer would be recorded in the accounting records and the
statement of financial position. Unless this computer was particularly unusual, however, it would be
included in the total of ‘property, plant and equipment’ line-item on the face of the statement of
financial position, but would not be separately disclosed anywhere in the financial statements since it
would not be relevant to the user when making his economic decisions.
Conversely, some items that are not recognised may need to be separately disclosed. This
happens where either the definition or recognition criteria (or both) are not met, but yet the
information is still expected to be relevant to users in making their economic decisions. For
example: a possible obligation arising from environmental legislation may not have been
recognised because it was subject to an unacceptable level of measurement and/ or
existence uncertainty, but it may need to be disclosed if this information could be useful to
users in making their economic decisions.
Recognition process
Is the definition of an element met? Would recognising the element provide
information that is:
x Relevant; and
x A faithful representation?
Are both the definition and recognition
criteria met?
Yes No
x Recognise; and where applicable Is the item relevant to the user?
x Present and disclose separately (if required by an
IFRS or if it is considered to be useful information)
Yes No
Disclose Ignore
9.2 The principles of presentation and disclosure (CF chapter 7)
In the same way that effective communication is vital for healthy relationships, it is also
fundamental in the process of financial reporting. A key component of this effective
communication is how elements are presented and/or disclosed to the users of the financial
information. This new section in the 2018 CF provides us with a principles-based approach to
presentation and disclosure.
Please note that these principles apply equally to elements that are recognised (i.e. those that
meet the definitions and recognition criteria) and to elements that are not recognised (i.e.
elements which failed the recognition criteria), but where it is believed that information about
these elements should be disclosed because users may find it useful.
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The main principle, as always, is to provide information that is relevant and a faithful representation
of the transactions and events (i.e. to give useful information). To achieve this, the entity must:
x focus on presentation and disclosure objectives and principles rather than focussing on rules;
x classify information in a manner that groups similar items and separates dissimilar items; and
x aggregate information in such a way that it is not obscured either by unnecessary detail or by
excessive aggregation.
The CF has stated that, in order to facilitate this effective communication between the reporting
entity and the users of its financial information, the IFRSs will be designed in such a way that a
balance is struck between:
x giving entities the flexibility to provide relevant information that faithfully represents the entity’s
assets, liabilities, equity, income, and expenses; and
x requiring information that is comparable, both from period to period for a reporting entity and in
a single reporting period across multiple entities.
As stated above, the CF guides entities towards a principles-based approach in presenting
information. In this regard, the principles stipulated in this CF are that:
x Entity-specific information is more useful than standardised descriptions; and
x Duplication of information in different parts of the financial statements is usually unnecessary and
can make financial statements less understandable.
10. Concepts of Capital and Capital Maintenance (CF: Chapter 8)
10.1 Capital
There are two possible concepts of capital:
x Financial concept of capital: capital relates to the net assets or equity of the company. This
concept is adopted by most entities in preparing their financial statements.
x Physical concept of capital: capital is regarded as the productive capacity of the entity, for
example 500 units of output per day.
The choice between these concepts depends on the needs of the users. If users are more interested
in the net worth of the company, then the financial concept makes more sense. If users are more
interested in the production capability, then the physical concept would be more appropriate.
10.2 Capital maintenance and determination of profit
Capital and profits are inter-linked. Each affects the other. The measurement of profits is affected by
the measurement of capital. Only the net inflow of assets that exceed the amounts needed to
maintain the capital base are regarded as profit. This, in a nutshell, is the concept of capital
maintenance. In other words, the concept of capital maintenance is the reflection of how a particular
entity ‘defines the capital that it seeks to maintain’. Thus ‘profit is the residual amount that remains
after expenses, including any maintenance adjustments, have been deducted from income’. A loss
arises if these expenses, including maintenance adjustments, exceed income. See CF 8.4
Thus, if the capital base is bigger at the end of the year compared to the beginning, a profit has been
made. How one measures this capital growth will thus affect the measurement of the profit (or loss):
x Financial capital maintenance: a profit is earned if the financial (money) amount of the net assets is
greater at the end of the period than at the beginning of the period, after excluding any distributions
to, or contributions from, owners during the period (e.g. dividends and share issues). This can be
measured in nominal monetary units or units of constant purchasing power. See CF 8.3 (a)
x Physical capital maintenance: a profit is earned only if the physical productive capacity of the
entity (or the resources or funds needed to achieve that capacity) at the end of the period
exceeds the capacity at the beginning of the period, after excluding any distributions to, or
contributions from, owners during the period. See CF 8.3 (b)
Capital maintenance adjustments are the revaluations or restatements of assets and liabilities that
give rise to increases or decreases in equity.
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11. Summary Comparison of old 2010 CF with new 2018 CF: Definitions and Recognition Criteria

Conceptual Framework for Financial Reporting

x objective of general-purpose financial reporting
x qualitative characteristics of useful financial information OLD 2010 CF - DEFINITIONS NEW 2018 CF - DEFINITIONS
x financial statements and the reporting entity An asset was defined as: An asset is defined as:
x the elements of financial statements x Resource x A present economic resource
x recognition and derecognition x Controlled by the entity x Controlled by the entity
x measurement x As a result of past events x Resulting from past events See CF 4.3
x presentation and disclosure x From which future economic benefits are
x concepts of capital and capital maintenance An economic resource is defined as:
expected to flow to the entity
x a right that has
See CF 4.4
x the potential to produce economic benefits
Objective of Qualitative Financial statements Measurement
A liability was defined as: A liability is defined as:
general-purpose characteristics and the reporting
financial reporting entity x Present obligation x A present obligation of the entity
x Of the entity x To transfer an economic resource
x provide financial info Fundamental: Financial statements: Measurement:
x about the entity x Relevance. Something is x The objective of x historical cost x As a result of past events x As a result of past events See CF 4.26
x that is useful to the relevant if it makes a financial statements x current cost x From which future economic benefits are A present obligation is a:
users * difference to user’s is to provide financial x value in use (assets) expected to flow from the entity x a duty or responsibility that an entity
x in making decisions decision-making, which information about the x fulfilment value x has no practical ability to avoid See CF 4.29
about providing will be the case if it has: reporting entity (liabilities)
resources to the  predictive value x That is useful to x fair values Equity was defined as: Equity is defined as:
entity  confirmatory value users of financial x Assets less x Assets less
Relevance is related to statements The last 3 are ‘current x Liabilities x Liabilities See CF 4.63 (reworded)
* Users (primary) = materiality (which is entity A reporting entity: values’ Income was defined as: Income is defined as:
existing and potential specific) x Is an entity that is
x An increase in economic benefits x Increases in assets, or
investors, lenders and x Faithful representation required, or chooses Measurement of an
x During the accounting period x Decreases in liabilities
other providers of  Complete to, prepare financial element can involve a
x In the form of increases in assets or decreases x Other than those relating to
capital  Neutral statements mixture of
in liabilities  contributions from holders of equity claims.
 Free from error x A reporting entity is measurement methods
See CF 4.68
Enhancing: not necessarily a legal e.g. initial measurement x Resulting in increases in equity
x Comparability entity at cost and subsequent x Other than contributions from equity participants
x Verifiability measurement at fair Expenses were defined as: Expenses are defined as:
x Timeliness value x A decrease in economic benefits x Decreases in assets, or
x Understandability
x During the accounting period x Increases in liabilities
x In the form of decreases in assets or increases x Other than those relating to
Elements in liabilities  Distributions to holders of equity claims.
See CF 4.68
(that have met the definitions) x Resulting in decreases in equity
x Other than distributions to equity participants

Is the information relevant? Is the information a faithful representation? OLD 2010 CF – RECOGNITION CRITERIA NEW 2018 CF - RECOGNITION CRITERIA
Recognition criteria were: Recognition criteria are:
x Future economic benefits probable Information must be:
Are both recognition criteria met?
x Reliably measurable x Relevant; and a
x Faithful representation
Yes No

x Recognise; and where applicable Is information about the element

x Present separately and disclose extra useful to the user? Measurement bases Example Entry price/ exit price
information (if required by a IFRS or if it is
considered necessary for fair presentation)
x Historical cost Entry price
Yes No  Cost Land or inventory Entry price
 Depreciated cost Plant under the cost model Entry price
Disclose Ignore
x Current value Entry/ Exit prices
 Current cost Replacement cost of an item of plant Entry price
 Fair value Investment property under the fair value model Exit price
 Value in use Use for certain assets when testing for impairment Exit price

72 Chapter 2 Chapter 2 73