CHAPTER 5 FRAMEWORK CONCEPT nancial statements TECHNICAL KNOWLEDGE To identify the elements directly related to the measurement of financial position and financial performance, To understand the concept of asset, liability and equity, To understand the conce, t of income and expenses, BE of ELEMENTS OF FINANCIAL STATEMENTS Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according ta their economic characteristics. ‘These broad classes are termed the elenients of financial statements, ‘The elements of financial statements refer to the quantitative information reported in the statement of financial position and income statement ‘The elements of financial statements are the "building blocks" from which financial statements are constructed ‘The presentation of these elements in the statement of financial position and the income statement involves a process of classification and subclassification. For example, assets and Liabilities may be classified by their nature or fune in the business of the entity in order to display information in a manner most useful to users for Purposes of making economic decisions. The elements directly related to the measurement of financial position. are: a. Asset b. Liability ce. Equity The elements directly related to the measurement of financial performance are: a. Income b. Expense ‘The Conceptual Framework identifies no elements that are unique to the statement of changes in equity because such statement comprises items that appear in the statement of financial position and the income statement. Equity is the residual interest in the assets of the entity after deducting all of the liabilities. 101ASSET | mework, an asse, Under the Revined Conceptual Framerci 2 ie canal defined as a present economic resource 6s a result of past events. ‘An economic resource ia a right that has the potentin | produce economic benefits. ean a 7 — wea ti ce etiglecomamie benefits 10 longs Reed 10 be expected io flow ta the entity. Essential characteristics of asset a. The asset is a present economic resource b. The resource isa right that has the potentia} i, economic produce economic benefits. ‘The economic resource is controlled by the entity as, « © result of past events. : Right ¢ : Rights that have the potential to produce economic benefits may take the following forms: L. Rights that correspond to an objigation of another entity Right to receive cash ; Right to receive goods or services c. Right to exchange economic resources with another rable terms d. Richt to benefit fom an obligation of another party! a specified uncertain. future event occurs 2 Rights that do not correspond to an obligation of another entity = Right over physical objects, such as property, plett and equipment or inventories b. Right to intellectual property 3. Rights established by contract or legislation such as ownint 4 debt instrument or an equity instrument or owning * registered patent, 102 OE Potential to produce economic benefits An economic resource is o produce economic bevejia,” "ht that has the potential to » id does not need to be certain or ven likely that the right will produce sett epee 1 ts only necessary that the right oiready exiaa, A right can meet the definition of an co a the probability that it wall produce ecnmoans Coreen ‘The economic revautce i the present ri srt that contains the ovential tnd no{ the Future economic beneGits thar the right ‘An economic resource could produce economic benefite if an entity is entitled a. To receive contractual cash flows b. To exchange economic resources with another party on favorable terms ¢- To produce cash inflows or avoid cash outflows 4. To receive cash by selling the economic resource e. - To extinguish a lisbility by transferring an economic resource Control of an economic resource ‘An entity controls an asset if it has the present ability to direct the use of the asset and obtain the ecanomic benefits that flow from it Control also includes the ability to prevent athers from using Such asset and therefore preventing others from obtaining the economic benefits from the asset. Control may arise if an entity enforces legal rights. If there are no legal rights, control can still exist if an entity has other means of ensuring that no other party can benefit from an asset. For example, an entity has access to technical know-how and has the ability to keep this know-how secret. 103LIAB a liability is defi Revised Conceptual Framework © economic recited «8 present obligation of a” entily lo Tee as a result of past events. eat definition clarifies thal eee as ‘economic resource ani economic benefits. The outflow of economic benefits no longer needs to be expected similar to the definition of an asset. Thi definition of liability to some extent is inconsistent with the definition of liability under IAS 37. In of conflict, the IASB stated that the requirements of a Standard shall always prevail over the Conceptual Framework. Essential characteristics of liability a. The entity has an obligation. The entity liable must be identified. It is not necessary that the payee or the entity to whom the obligation is owed be identified. b. The obligation is to transfer an economic resource. c. The obligation is a present obligation that exists as a result of past event. This means that a liability i . as incurred. liability is not recognized until itis Obligation liability is the obligation id not the ultimate outfloy, & An obligation is a duty or responsibilit: i 7 ni 0 onsibility that an entity has no practical ability 'o avoid. Obligations can either be legal or Obligations may be legal H gally enforceabl. of @ binding contract or statutory requirement. This is normally the . for goods and Services esc example, with accounts payable Constructi izatic A custom and ¢ a paiations arise from normal business practic: in an equitable mannoenint#in good business relations or #*t For example, an e1 i 1 faults in the’ ntity decides as a matter of policy to rectify the warranty pects even when these become apparent afte" 104 qransfer of an economic resource Obligations to transfer an economic resource includet a, Obligation to pay cash b. Obligation to deliver goods or noncash resources c. Obligation to provide services at some future time d. Obligation to exchange economic resources with another party on unfavorable terms e, Obligation to transfer an economic resource if specified uncertain future event occurs Past event An obligation exists as a result of past event if both of the following conditions are satisfied: a. An entity has already obtained economic benefits. b. An entity must transfer an economic resource. Definition of income Income is defined as increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from equity holders. The definition of income has changed to reflect the change in ‘the definition of asset and liability. The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary regular activities and is referred to by variety of different names including sales, fees, interest, dividends, royalties and rent ‘The essence of revenue is regularity. at meet the definition of income Gains re her items thi incor eine in f the ordinary regular activities. &nd do not arise in the course 0! ofnoncurrent asset, unrealized Gains include gain from disposal nom expropriation. Bain on trading investment and &! 105Statement of financial performance The Revised Conceptual Framework introduces the term statement of financial performance. ‘This statement refers to the statement of profit or loss and a statement presenting other comprehensive income. The statement of profit or loss is the primary source of information about an entity's financial performance. As a general rule, all income and expenses are included in profit or loss. However, in developing accounting standards, there are some items of income and expenses that are included in other comprehensive income and not in profit or loss if such presentation would provide more relevant and faithfully represented information about financial performance. There are instances that an amount in other comprehensive income in one reporting period may be recycled to profit or loss in another reporting period. Such recycling is permitted as long as it would result to relevant and faithfully represented information about financial performance. Definition of expense Expense is defined as decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to equity holders. The definition of expense has changed to reflect the change in the definition of asset and liability. Expenses encompass losses as well as those expenses: that arise in the course of the ordinary regular activities. Expenses that arise in the course of ordinary regular activities include cost of goods sold, wages and depreciatio™ Losses do not arise in the course of the ordinary regular activities and include losses resulting from disasters. Examples include losses from fire, flood, storm surge, tsuna™* and hurricane, as well as th i F of noncurrent assets. ose arising from disposal 106 QUESTIONS 1, Define elements of financial statements. 2,What are the elements directly related to the measurement of financial position? 3. What are the elements directly related to the measurement of financial performance? 4, Define an asset. 5. What are the essential characteristics of an asset? 6. Explain a right to produce economic benefit. 7. Explain control of an economic resource. 8, Define a liability. 9, What are the essential characteristics of a Liability? 10. Explain an obligation. 11 Explain transfer of economic resources. 12. Define income. 18, Distinguish income from revenue: 14. Define an expense 18. Distinguish expenses from loss. 107