situations, the entity has an obligation if it has no practical ability to avoid taking that
action. [CF 4.32].
A conclusion that it is appropriate to prepare an entity’s financial statements on a going
concern basis also implies a conclusion that the entity has no practical ability to avoid a
transfer that could be avoided only by liquidating the entity or by ceasing to trade.
[CF 4.33].
The factors used to assess whether an entity has the practical ability to avoid
transferring an economic resource may depend on the nature of the entity’s duty or
responsibility. For example, in some cases, an entity may have no practical ability to
avoid a transfer if any action that it could take to avoid the transfer would have
economic consequences significantly more adverse than the transfer itself. However,
neither an intention to make a transfer, nor a high likelihood of a transfer, is sufficient
reason for concluding that the entity has no practical ability to avoid a transfer. [CF 4.34].
In some cases, it is uncertain whether an obligation exists. For example, if another party
is seeking compensation for an entity’s alleged act of wrongdoing, it might be uncertain
whether the act occurred, whether the entity committed it or how the law applies. Until
that existence uncertainty is resolved, for example, by a court ruling, it is uncertain
whether the entity has an obligation to the party seeking compensation and,
consequently, whether a liability exists (see 8.2.1.A below). [CF 4.35].
7.3.2
Transfer an economic resource
The second criterion for a liability is that the obligation is to transfer an economic
resource. To satisfy this criterion, the obligation must have the potential to require the
entity to transfer an economic resource to another party (or parties). For that potential
to exist, it does not need to be certain, or even likely, that the entity will be required to
transfer an economic resource; the transfer may, for example, be required only if a
specified uncertain future event occurs. It is only necessary that the obligation already
exists and that, in at least one circumstance, it would require the entity to transfer an
economic resource. [CF 4.36, 37].
An obligation can meet the definition of a liability even if the probability of a transfer of
an economic resource is low. Nevertheless, that low probability might affect decisions
about what information to provide about the liability and how to provide that
information, including decisions about whether the liability is recognised (see 8.2.1.B
below) and how it is measured (discussed at 9 below). [CF 4.38].
Obligations to transfer an economic resource include, for example, obligations to:
• pay cash;
• deliver goods or provide services;
• exchange economic resources with another party on unfavourable terms. Such
obligations include, for example, a forward contract to sell an economic resource
The IASB’s Conceptual Framework
69
on terms that are currently unfavourable or an option that entitles another party to
buy an economic resource from the entity;
• transfer an economic resource if a specified uncertain future event occurs; and
• issue a financial instrument if that financial instrument will oblige the entity to
transfer an economic resource. [CF 4.39].
Instead of fulfilling an obligation to transfer an economic resource to the party that has
a right to receive that resource, entities sometimes decide to, for example:
• settle the obligation by negotiating a release from the obligation;
• transfer the obligation to a third party; or
• replace that obligation to transfer an economic resource with another obligation
by entering into a new transaction.
In these situations, an entity has the obligation to transfer an economic resource
until it has settled, transferred or replaced that obligation. [CF 4.40, 4.41].
7.3.3
Present obligation existing as a result of past events
The third criterion for a liability is that the obligation is a present obligation that exists
as a result of past events. That is:
• the entity has already obtained economic benefits or taken an action; and
• as a consequence, the entity will or may have to transfer an economic resource
that it would not otherwise have had to transfer. [CF 4.42, 43].
The economic benefits obtained could include, for example, goods or services. The
action taken could include, for example, operating a particular business or operating in
a particular market. If economic benefits are obtained, or an action is taken, over time,
the resulting present obligation may accumulate over that time. [CF 4.44].
If new legislation is enacted, a present obligation arises only when, as a consequence
of obtaining economic benefits or taking an action to which that legislation applies, an
entity will or may have to transfer an economic resource that it would not otherwise
have had to transfer. The enactment of legislation is not in itself sufficient to give an
entity a present obligation. Similarly, an entity’s customary practice, published policy
or specific statement of the type mentioned at 7.3.1 above gives rise to a present
obligation only when, as a consequence of obtaining economic benefits, or taking an
action, to which that practice, policy or statement applies, the entity will or may have
to transfer an economic resource that it would not otherwise have had to transfer.
[CF 4.45].
A present obligation can exist even if a transfer of economic resources cannot be
enforced until some point in the future. For example, a contractual liability to pay cash
may exist now even if the contract does not require a payment until a future date.
Similarly, a contractual obligation for an entity to perform work at a future date may
exist now even if the counterparty cannot require the entity to perform the work until
that future date. [CF 4.46].
An entity does not yet have a present obligation to transfer an economic resource if it has
not yet obtained economic benefits, or taken an action, that would or could require the
entity to transfer an economic resource that it would not otherwise have had to transfer.
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For example, if an entity has entered into a contract to pay an employee a salary in
exchange for receiving the employee’s services, the entity does not have a present
obligation to pay the salary until it has received the employee’s services. Before then the
contract is executory; the entity has a combined right and obligation to exchange future
salary for future employee services (executory contracts are discussed at 7.1.2 above).
[CF 4.47].
7.4 Definition
of
equity
As noted as 7 above, equity is the residual interest in the assets of the entity after
deducting all its liabilities; accordingly, equity claims are claims on this residual interest.
Put another way, equity claims are claims against the entity that do not meet the
definition of a liability. Such claims may be established by contract, legislation or similar
means, and include, to the extent that they do not meet the definition of a liability:
• sh
ares of various types, issued by the entity; and
• some obligations of the entity to issue another equity claim. [CF 4.63, 64].
Different classes of equity claims, such as ordinary shares and preference shares, may
confer on their holders different rights, for example, rights to receive some or all of the
following from the entity:
• dividends, if the entity decides to pay dividends to eligible holders;
• the proceeds from satisfying the equity claims, either in full on liquidation, or in
part at other times; or
• other equity claims. [CF 4.65].
Sometimes, legal, regulatory or other requirements affect particular components of
equity, such as share capital or retained earnings. For example, some such
requirements permit an entity to make distributions to holders of equity claims only
if the entity has sufficient reserves that those requirements specify as being
distributable. [CF 4.66].
Business activities are often undertaken by entities such as sole proprietorships,
partnerships, trusts or various types of government business undertakings. The legal and
regulatory frameworks for such entities are often different from frameworks that apply
to corporate entities. For example, there may be few, if any, restrictions on the
distribution to holders of equity claims against such entities. Nevertheless, the
Framework makes clear that the definition of equity applies to all reporting entities.
[CF 4.67].
7.5
Definition of income and expenses
Income and expenses are the elements of financial statements that relate to an entity’s
financial performance. Users of financial statements need information about both an
entity’s financial position and its financial performance. Hence, although income and
expenses are defined in terms of changes in assets and liabilities, information about
income and expenses is just as important as information about assets and liabilities.
[CF 4.71].
The IASB’s Conceptual Framework
71
• Income is increases in assets, or decreases in liabilities, that result in increases in
equity, other than those relating to contributions from holders of equity claims;
• Expenses are decreases in assets, or increases in liabilities, that result in decreases
in equity, other than those relating to distributions to holders of equity claims;
each excluding those relating to contributions from holders of equity claims;
accordingly:
• Contributions from holders of equity claims are not income; and
• Distributions to holders of equity claims are not expenses. [CF 4.68-70].
Different transactions and other events generate income and expenses with different
characteristics. Providing information separately about income and expenses with
different characteristics can help users of financial statements to understand the entity’s
financial performance (see 10.2.3.A below). [CF 4.72].
8
CHAPTER 5: RECOGNITION AND DERECOGNITION
Recognition is described in the Framework as the process of capturing for inclusion in
the statement of financial position or the statement(s) of financial performance an item
that meets the definition of one of the elements of financial statements (that is, an asset,
a liability, equity, income or expenses).
8.1
The recognition process
Recognition involves depicting the item in one of those statements (either alone or in
aggregation with other items) in words and by a monetary amount, and including that
amount in one or more totals in that statement. The amount at which an asset, a liability
or equity is recognised in the statement of financial position is referred to as its ‘carrying
amount’. [CF 5.1].
The statement of financial position and statement(s) of financial performance depict an
entity’s recognised assets, liabilities, equity, income and expenses in structured
summaries that are designed to make financial information comparable and
understandable. An important feature of the structures of those summaries is that the
amounts recognised in a statement are included in the totals and, if applicable, subtotals
that link the items recognised in the statement. [CF 5.2].
Recognition links the elements, the statement of financial position and the statement(s)
of financial performance as follows:
• in the statement of financial position at the beginning and end of the reporting
period, total assets minus total liabilities equal total equity; and
• recognised changes in equity during the reporting period comprise:
• income minus expenses recognised in the statement(s) of financial
performance; plus
• contributions from holders of equity claims, minus distributions to holders of
equity claims. [CF 5.3].
This is illustrated diagrammatically in Figure 2.2 below.
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Figure 2.2 How recognition links the elements of financial statements
Statement of financial position at beginning of reporting period
Assets minu
+
s liabilities equal equity
Statement(s) of financial performance
Income +
minus expenses
Changes
in equity
Contributions from holders of equity claims minus distributions
to ho
=
lders of equity claims
Statement of financial position at end of reporting period
Assets minus liabilities equal equity
The statements of financial position and performance are linked because the
recognition of one item (or a change in its carrying amount) requires the recognition or
derecognition of one or more other items (or changes in the carrying amount of one or
more other items). This is the familiar concept of ‘double-entry’ and the Framework
provides the following description:
• the recognition of income occurs at the same time as:
• the initial recognition of an asset, or an increase in the carrying amount of an
asset; or
• the derecognition of a liability, or a decrease in the carrying amount of a
liability;
• the recognition of expenses occurs at the same time as:
• the initial recognition of a liability, or an increase in the carrying amount of a
liability; or
• the derecognition of an asset, or a decrease in the carrying amount of an asset.
[CF 5.4].
The initial recognition of assets or liabilities arising from transactions or other events
may result in the simultaneous recognition of both income and related expenses. For
example, the sale of goods for cash results in the recognition of both income (from the
recognition of one asset, being the cash) and an expense (from the derecognition of
another asset, being the goods sold). The simultaneous recognition of income and
related expenses is sometimes referred to as the matching of costs with income.
Application of the concepts in the Framework leads to such matching when it arises
from the recognition of changes in assets and liabilities. However, matching of costs
with income is not an objective of the Framework. The Framework does not allow the
The IASB’s Conceptual Framework
recognition in the statement of financial position of items that do not meet the definition
of an asset, a liability or equity. [CF 5.5].
8.2 Recognition
criteria
Only items that meet the definition of an asset, a liability or equity are recognised in the
statement of financial position. Similarly, only items that meet the definition of income
or expenses are recognised in the statement(s) of financial performance. However, not
all items that meet the definition of one of those elements are recognised. [CF 5.6].
Not recognising an item that meets the definition of one of the elements makes the
statement of financial position and the statement(s) of financial performance less
complete and can exclude useful information from financial statements. On the other
hand, in some circumstances, recognising some items that meet the definition of one of
the elements would not provide useful information. An asset or liability is recognised
only if recognition of that asset or liability and of any resulting income, expenses or
changes in equity provides users of financial statements with information that is useful;
that is, with:
• relevant information about the asset or liability and about any resulting income,
expenses or changes in equity (see 8.2.1 below); and
• a faithful representation of the asset or liability and of any resulting income,
expenses or changes in equity (see 8.2.2). [CF 5.7].
Just as cost constrains other financial reporting decisions, it also constrains recognition
decisions. There is a cost to recognising an asset or liability. Preparers of financial
statements incur costs in obtaining a relevant measure of an asset or liability. Users of
financial statements also incur costs in analysing and interpreting the information
provided. An asset or liability is recognised if the benefits of the information provided
to users of financial statements by recognition are likely to justify the costs of providing
and using that information. In some cases, the costs of recognition may outweigh its
benefits. [CF 5.8].
It is not possible to define precisely when recognition of an asset or liability will provide
useful information to users of financial statements, at a cost that does not outweigh its
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