conceptual-framework-for-financial-reporting.pdf

Conceptual Framework Conceptual Framework for Financial Reporting Conceptual Framework for Financial Reporting was issued by the International Accounting Standards Board in September 2010. It was revised in March 2018....

Conceptual Framework Conceptual Framework for Financial Reporting Conceptual Framework for Financial Reporting was issued by the International Accounting Standards Board in September 2010. It was revised in March 2018. © IFRS Foundation A9 Conceptual Framework CONTENTS from paragraph STATUS AND PURPOSE OF THE CONCEPTUAL FRAMEWORK SP1.1 CHAPTER 1—THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING INTRODUCTION 1.1 OBJECTIVE, USEFULNESS AND LIMITATIONS OF GENERAL PURPOSE FINANCIAL REPORTING 1.2 INFORMATION ABOUT A REPORTING ENTITY’S ECONOMIC RESOURCES, CLAIMS AGAINST THE ENTITY AND CHANGES IN RESOURCES AND CLAIMS 1.12 Economic resources and claims 1.13 Changes in economic resources and claims 1.15 Financial performance reflected by accrual accounting 1.17 Financial performance reflected by past cash flows 1.20 Changes in economic resources and claims not resulting from financial performance 1.21 INFORMATION ABOUT USE OF THE ENTITY’S ECONOMIC RESOURCES 1.22 CHAPTER 2—QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION INTRODUCTION 2.1 QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION 2.4 Fundamental qualitative characteristics 2.5 Enhancing qualitative characteristics 2.23 THE COST CONSTRAINT ON USEFUL FINANCIAL REPORTING 2.39 CHAPTER 3—FINANCIAL STATEMENTS AND THE REPORTING ENTITY FINANCIAL STATEMENTS 3.1 Objective and scope of financial statements 3.2 Reporting period 3.4 Perspective adopted in financial statements 3.8 Going concern assumption 3.9 THE REPORTING ENTITY 3.10 Consolidated and unconsolidated financial statements 3.15 CHAPTER 4—THE ELEMENTS OF FINANCIAL STATEMENTS INTRODUCTION 4.1 DEFINITION OF AN ASSET 4.3 Right 4.6 Potential to produce economic benefits 4.14 continued... A10 © IFRS Foundation  Conceptual Framework...continued Control 4.19 DEFINITION OF A LIABILITY 4.26 Obligation 4.28 Transfer of an economic resource 4.36 Present obligation as a result of past events 4.42 ASSETS AND LIABILITIES 4.48 Unit of account 4.48 Executory contracts 4.56 Substance of contractual rights and contractual obligations 4.59 DEFINITION OF EQUITY 4.63 DEFINITIONS OF INCOME AND EXPENSES 4.68 CHAPTER 5—RECOGNITION AND DERECOGNITION THE RECOGNITION PROCESS 5.1 RECOGNITION CRITERIA 5.6 Relevance 5.12 Faithful representation 5.18 DERECOGNITION 5.26 CHAPTER 6—MEASUREMENT INTRODUCTION 6.1 MEASUREMENT BASES 6.4 Historical cost 6.4 Current value 6.10 INFORMATION PROVIDED BY PARTICULAR MEASUREMENT BASES 6.23 Historical cost 6.24 Current value 6.32 FACTORS TO CONSIDER WHEN SELECTING A MEASUREMENT BASIS 6.43 Relevance 6.49 Faithful representation 6.58 Enhancing qualitative characteristics and the cost constraint 6.63 Factors specific to initial measurement 6.77 More than one measurement basis 6.83 MEASUREMENT OF EQUITY 6.87 CASH-FLOW-BASED MEASUREMENT TECHNIQUES 6.91 CHAPTER 7—PRESENTATION AND DISCLOSURE PRESENTATION AND DISCLOSURE AS COMMUNICATION TOOLS 7.1 PRESENTATION AND DISCLOSURE OBJECTIVES AND PRINCIPLES 7.4 CLASSIFICATION 7.7 continued... © IFRS Foundation A11 Conceptual Framework...continued Classification of assets and liabilities 7.9 Classification of equity 7.12 Classification of income and expenses 7.14 AGGREGATION 7.20 CHAPTER 8—CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE CONCEPTS OF CAPITAL 8.1 CONCEPTS OF CAPITAL MAINTENANCE AND THE DETERMINATION OF PROFIT 8.3 CAPITAL MAINTENANCE ADJUSTMENTS 8.10 APPENDIX—DEFINED TERMS APPROVAL BY THE BOARD OF THE CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING ISSUED IN MARCH 2018 FOR THE BASIS FOR CONCLUSIONS, SEE PART C OF THIS EDITION BASIS FOR CONCLUSIONS A12 © IFRS Foundation  Conceptual Framework STATUS AND PURPOSE OF THE CONCEPTUAL FRAMEWORK SP1.1 The Conceptual Framework for Financial Reporting (Conceptual Framework) describes the objective of, and the concepts for, general purpose financial reporting. The purpose of the Conceptual Framework is to: (a) assist the International Accounting Standards Board (Board) to develop IFRS Standards (Standards) that are based on consistent concepts; (b) assist preparers to develop consistent accounting policies when no Standard applies to a particular transaction or other event, or when a Standard allows a choice of accounting policy; and (c) assist all parties to understand and interpret the Standards. SP1.2 The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard. SP1.3 To meet the objective of general purpose financial reporting, the Board may sometimes specify requirements that depart from aspects of the Conceptual Framework. If the Board does so, it will explain the departure in the Basis for Conclusions on that Standard. SP1.4 The Conceptual Framework may be revised from time to time on the basis of the Board’s experience of working with it. Revisions of the Conceptual Framework will not automatically lead to changes to the Standards. Any decision to amend a Standard would require the Board to go through its due process for adding a project to its agenda and developing an amendment to that Standard. SP1.5 The Conceptual Framework contributes to the stated mission of the IFRS Foundation and of the Board, which is part of the IFRS Foundation. That mission is to develop Standards that bring transparency, accountability and efficiency to financial markets around the world. The Board’s work serves the public interest by fostering trust, growth and long-term financial stability in the global economy. The Conceptual Framework provides the foundation for Standards that: (a) contribute to transparency by enhancing the international comparability and quality of financial information, enabling investors and other market participants to make informed economic decisions. (b) strengthen accountability by reducing the information gap between the providers of capital and the people to whom they have entrusted their money. Standards based on the Conceptual Framework provide information needed to hold management to account. As a source of globally comparable information, those Standards are also of vital importance to regulators around the world. (c) contribute to economic efficiency by helping investors to identify opportunities and risks across the world, thus improving capital allocation. For businesses, the use of a single, trusted accounting language derived from Standards based on the Conceptual Framework lowers the cost of capital and reduces international reporting costs. © IFRS Foundation A13 Conceptual Framework CONTENTS from paragraph CHAPTER 1—THE OBJECTIVE OF GENERAL PURPOSE FINANCIAL REPORTING INTRODUCTION 1.1 OBJECTIVE, USEFULNESS AND LIMITATIONS OF GENERAL PURPOSE FINANCIAL REPORTING 1.2 INFORMATION ABOUT A REPORTING ENTITY’S ECONOMIC RESOURCES, CLAIMS AGAINST THE ENTITY AND CHANGES IN RESOURCES AND CLAIMS 1.12 Economic resources and claims 1.13 Changes in economic resources and claims 1.15 Financial performance reflected by accrual accounting 1.17 Financial performance reflected by past cash flows 1.20 Changes in economic resources and claims not resulting from financial performance 1.21 INFORMATION ABOUT USE OF THE ENTITY’S ECONOMIC RESOURCES 1.22 A14 © IFRS Foundation  Conceptual Framework Introduction 1.1 The objective of general purpose financial reporting forms the foundation of the Conceptual Framework. Other aspects of the Conceptual Framework—the qualitative characteristics of, and the cost constraint on, useful financial information, a reporting entity concept, elements of financial statements, recognition and derecognition, measurement, presentation and disclosure — flow logically from the objective. Objective, usefulness and limitations of general purpose financial reporting 1.2 The objective of general purpose financial reporting1 is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity.2 Those decisions involve decisions about: (a) buying, selling or holding equity and debt instruments; (b) providing or settling loans and other forms of credit; or (c) exercising rights to vote on, or otherwise influence, management’s actions that affect the use of the entity’s economic resources. 1.3 The decisions described in paragraph 1.2 depend on the returns that existing and potential investors, lenders and other creditors expect, for example, dividends, principal and interest payments or market price increases. Investors’, lenders’ and other creditors’ expectations about returns depend on their assessment of the amount, timing and uncertainty of (the prospects for) future net cash inflows to the entity and on their assessment of management’s stewardship of the entity’s economic resources. Existing and potential investors, lenders and other creditors need information to help them make those assessments. 1.4 To make the assessments described in paragraph 1.3, existing and potential investors, lenders and other creditors need information about: (a) the economic resources of the entity, claims against the entity and changes in those resources and claims (see paragraphs 1.12–1.21); and (b) how efficiently and effectively the entity’s management and governing board3 have discharged their responsibilities to use the entity’s economic resources (see paragraphs 1.22–1.23). 1 Throughout the Conceptual Framework, the terms ‘financial reports’ and ‘financial reporting’ refer to general purpose financial reports and general purpose financial reporting unless specifically indicated otherwise. 2 Throughout the Conceptual Framework, the term ‘entity’ refers to the reporting entity unless specifically indicated otherwise. 3 Throughout the Conceptual Framework, the term ‘management’ refers to management and the governing board of an entity unless specifically indicated otherwise. © IFRS Foundation A15 Conceptual Framework 1.5 Many existing and potential investors, lenders and other creditors cannot require reporting entities to provide information directly to them and must rely on general purpose financial reports for much of the financial information they need. Consequently, they are the primary users to whom general purpose financial reports are directed.4 1.6 However, general purpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders and other creditors need. Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks. 1.7 General purpose financial reports are not designed to show the value of a reporting entity; but they provide information to help existing and potential investors, lenders and other creditors to estimate the value of the reporting entity. 1.8 Individual primary users have different, and possibly conflicting, information needs and desires. The Board, in developing Standards, will seek to provide the information set that will meet the needs of the maximum number of primary users. However, focusing on common information needs does not prevent the reporting entity from including additional information that is most useful to a particular subset of primary users. 1.9 The management of a reporting entity is also interested in financial information about the entity. However, management need not rely on general purpose financial reports because it is able to obtain the financial information it needs internally. 1.10 Other parties, such as regulators and members of the public other than investors, lenders and other creditors, may also find general purpose financial reports useful. However, those reports are not primarily directed to these other groups. 1.11 To a large extent, financial reports are based on estimates, judgements and models rather than exact depictions. The Conceptual Framework establishes the concepts that underlie those estimates, judgements and models. The concepts are the goal towards which the Board and preparers of financial reports strive. As with most goals, the Conceptual Framework’s vision of ideal financial reporting is unlikely to be achieved in full, at least not in the short term, because it takes time to understand, accept and implement new ways of analysing transactions and other events. Nevertheless, establishing a goal towards which to strive is essential if financial reporting is to evolve so as to improve its usefulness. 4 Throughout the Conceptual Framework, the terms ‘primary users’ and ‘users’ refer to those existing and potential investors, lenders and other creditors who must rely on general purpose financial reports for much of the financial information they need. A16 © IFRS Foundation  Conceptual Framework Information about a reporting entity’s economic resources, claims against the entity and changes in resources and claims 1.12 General purpose financial reports provide information about the financial position of a reporting entity, which is information about the entity’s economic resources and the claims against the reporting entity. Financial reports also provide information about the effects of transactions and other events that change a reporting entity’s economic resources and claims. Both types of information provide useful input for decisions relating to providing resources to an entity. Economic resources and claims 1.13 Information about the nature and amounts of a reporting entity’s economic resources and claims can help users to identify the reporting entity’s financial strengths and weaknesses. That information can help users to assess the reporting entity’s liquidity and solvency, its needs for additional financing and how successful it is likely to be in obtaining that financing. That information can also help users to assess management’s stewardship of the entity’s economic resources. Information about priorities and payment requirements of existing claims helps users to predict how future cash flows will be distributed among those with a claim against the reporting entity. 1.14 Different types of economic resources affect a user’s assessment of the reporting entity’s prospects for future cash flows differently. Some future cash flows result directly from existing economic resources, such as accounts receivable. Other cash flows result from using several resources in combination to produce and market goods or services to customers. Although those cash flows cannot be identified with individual economic resources (or claims), users of financial reports need to know the nature and amount of the resources available for use in a reporting entity’s operations. Changes in economic resources and claims 1.15 Changes in a reporting entity’s economic resources and claims result from that entity’s financial performance (see paragraphs 1.17–1.20) and from other events or transactions such as issuing debt or equity instruments (see paragraph 1.21). To properly assess both the prospects for future net cash inflows to the reporting entity and management’s stewardship of the entity’s economic resources, users need to be able to identify those two types of changes. 1.16 Information about a reporting entity’s financial performance helps users to understand the return that the entity has produced on its economic resources. Information about the return the entity has produced can help users to assess management’s stewardship of the entity’s economic resources. Information about the variability and components of that return is also important, especially in assessing the uncertainty of future cash flows. Information about a reporting entity’s past financial performance and how its management discharged its stewardship responsibilities is usually helpful in predicting the entity’s future returns on its economic resources. © IFRS Foundation A17 Conceptual Framework Financial performance reflected by accrual accounting 1.17 Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period. This is important because information about a reporting entity’s economic resources and claims and changes in its economic resources and claims during a period provides a better basis for assessing the entity’s past and future performance than information solely about cash receipts and payments during that period. 1.18 Information about a reporting entity’s financial performance during a period, reflected by changes in its economic resources and claims other than by obtaining additional resources directly from investors and creditors (see paragraph 1.21), is useful in assessing the entity’s past and future ability to generate net cash inflows. That information indicates the extent to which the reporting entity has increased its available economic resources, and thus its capacity for generating net cash inflows through its operations rather than by obtaining additional resources directly from investors and creditors. Information about a reporting entity’s financial performance during a period can also help users to assess management’s stewardship of the entity’s economic resources. 1.19 Information about a reporting entity’s financial performance during a period may also indicate the extent to which events such as changes in market prices or interest rates have increased or decreased the entity’s economic resources and claims, thereby affecting the entity’s ability to generate net cash inflows. Financial performance reflected by past cash flows 1.20 Information about a reporting entity’s cash flows during a period also helps users to assess the entity’s ability to generate future net cash inflows and to assess management’s stewardship of the entity’s economic resources. That information indicates how the reporting entity obtains and spends cash, including information about its borrowing and repayment of debt, cash dividends or other cash distributions to investors, and other factors that may affect the entity’s liquidity or solvency. Information about cash flows helps users understand a reporting entity’s operations, evaluate its financing and investing activities, assess its liquidity or solvency and interpret other information about financial performance. Changes in economic resources and claims not resulting from financial performance 1.21 A reporting entity’s economic resources and claims may also change for reasons other than financial performance, such as issuing debt or equity instruments. Information about this type of change is necessary to give users a complete understanding of why the reporting entity’s economic resources and claims changed and the implications of those changes for its future financial performance. A18 © IFRS Foundation  Conceptual Framework Information about use of the entity’s economic resources 1.22 Information about how efficiently and effectively the reporting entity’s management has discharged its responsibilities to use the entity’s economic resources helps users to assess management’s stewardship of those resources. Such information is also useful for predicting how efficiently and effectively management will use the entity’s economic resources in future periods. Hence, it can be useful for assessing the entity’s prospects for future net cash inflows. 1.23 Examples of management’s responsibilities to use the entity’s economic resources include protecting those resources from unfavourable effects of economic factors, such as price and technological changes, and ensuring that the entity complies with applicable laws, regulations and contractual provisions. © IFRS Foundation A19 Conceptual Framework CONTENTS from paragraph CHAPTER 2—QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION INTRODUCTION 2.1 QUALITATIVE CHARACTERISTICS OF USEFUL FINANCIAL INFORMATION 2.4 Fundamental qualitative characteristics 2.5 Relevance 2.6 Materiality 2.11 Faithful representation 2.12 Applying the fundamental qualitative characteristics 2.20 Enhancing qualitative characteristics 2.23 Comparability 2.24 Verifiability 2.30 Timeliness 2.33 Understandability 2.34 Applying the enhancing qualitative characteristics 2.37 THE COST CONSTRAINT ON USEFUL FINANCIAL REPORTING 2.39 A20 © IFRS Foundation  Conceptual Framework Introduction 2.1 The qualitative characteristics of useful financial information discussed in this chapter identify the types of information that are likely to be most useful to the existing and potential investors, lenders and other creditors for making decisions about the reporting entity on the basis of information in its financial report (financial information). 2.2 Financial reports provide information about the reporting entity’s economic resources, claims against the reporting entity and the effects of transactions and other events and conditions that change those resources and claims. (This information is referred to in the Conceptual Framework as information about the economic phenomena.) Some financial reports also include explanatory material about management’s expectations and strategies for the reporting entity, and other types of forward-looking information. 2.3 The qualitative characteristics of useful financial information5 apply to financial information provided in financial statements, as well as to financial information provided in other ways. Cost, which is a pervasive constraint on the reporting entity’s ability to provide useful financial information, applies similarly. However, the considerations in applying the qualitative characteristics and the cost constraint may be different for different types of information. For example, applying them to forward-looking information may be different from applying them to information about existing economic resources and claims and to changes in those resources and claims. Qualitative characteristics of useful financial information 2.4 If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable, verifiable, timely and understandable. Fundamental qualitative characteristics 2.5 The fundamental qualitative characteristics are relevance and faithful representation. Relevance 2.6 Relevant financial information is capable of making a difference in the decisions made by users. Information may be capable of making a difference in a decision even if some users choose not to take advantage of it or are already aware of it from other sources. 2.7 Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value or both. 5 Throughout the Conceptual Framework, the terms ‘qualitative characteristics’ and ‘cost constraint’ refer to the qualitative characteristics of, and the cost constraint on, useful financial information. © IFRS Foundation A21 Conceptual Framework 2.8 Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes. Financial information need not be a prediction or forecast to have predictive value. Financial information with predictive value is employed by users in making their own predictions. 2.9 Financial information has confirmatory value if it provides feedback about (confirms or changes) previous evaluations. 2.10 The predictive value and confirmatory value of financial information are interrelated. Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, can also be compared with revenue predictions for the current year that were made in past years. The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions. Materiality 2.11 Information is material if omitting, misstating or obscuring it could reasonably be expected to influence decisions that the primary users of general purpose financial reports (see paragraph 1.5) make on the basis of those reports, which provide financial information about a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to which the information relates in the context of an individual entity’s financial report. Consequently, the Board cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation. Faithful representation 2.12 Financial reports represent economic phenomena in words and numbers. To be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the substance of the phenomena that it purports to represent. In many circumstances, the substance of an economic phenomenon and its legal form are the same. If they are not the same, providing information only about the legal form would not faithfully represent the economic phenomenon (see paragraphs 4.59–4.62). 2.13 To be a perfectly faithful representation, a depiction would have three characteristics. It would be complete, neutral and free from error. Of course, perfection is seldom, if ever, achievable. The Board’s objective is to maximise those qualities to the extent possible. 2.14 A complete depiction includes all information necessary for a user to understand the phenomenon being depicted, including all necessary descriptions and explanations. For example, a complete depiction of a group of assets would include, at a minimum, a description of the nature of the assets in the group, a numerical depiction of all of the assets in the group, and a description of what the numerical depiction represents (for example, historical cost or fair value). For some items, a complete depiction may also entail explanations of significant facts about the quality and nature of the A22 © IFRS Foundation  Conceptual Framework items, factors and circumstances that might affect their quality and nature, and the process used to determine the numerical depiction. 2.15 A neutral depiction is without bias in the selection or presentation of financial information. A neutral depiction is not slanted, weighted, emphasised, de-emphasised or otherwise manipulated to increase the probability that financial information will be received favourably or unfavourably by users. Neutral information does not mean information with no purpose or no influence on behaviour. On the contrary, relevant financial information is, by definition, capable of making a difference in users’ decisions. 2.16 Neutrality is supported by the exercise of prudence. Prudence is the exercise of caution when making judgements under conditions of uncertainty. The exercise of prudence means that assets and income are not overstated and liabilities and expenses are not understated.6 Equally, the exercise of prudence does not allow for the understatement of assets or income or the overstatement of liabilities or expenses. Such misstatements can lead to the overstatement or understatement of income or expenses in future periods. 2.17 The exercise of prudence does not imply a need for asymmetry, for example, a systematic need for more persuasive evidence to support the recognition of assets or income than the recognition of liabilities or expenses. Such asymmetry is not a qualitative characteristic of useful financial information. Nevertheless, particular Standards may contain asymmetric requirements if this is a consequence of decisions intended to select the most relevant information that faithfully represents what it purports to represent. 2.18 Faithful representation does not mean accurate in all respects. Free from error means there are no errors or omissions in the description of the phenomenon, and the process used to produce the reported information has been selected and applied with no errors in the process. In this context, free from error does not mean perfectly accurate in all respects. For example, an estimate of an unobservable price or value cannot be determined to be accurate or inaccurate. However, a representation of that estimate can be faithful if the amount is described clearly and accurately as being an estimate, the nature and limitations of the estimating process are explained, and no errors have been made in selecting and applying an appropriate process for developing the estimate. 2.19 When monetary amounts in financial reports cannot be observed directly and must instead be estimated, measurement uncertainty arises. The use of reasonable estimates is an essential part of the preparation of financial information and does not undermine the usefulness of the information if the estimates are clearly and accurately described and explained. Even a high level of measurement uncertainty does not necessarily prevent such an estimate from providing useful information (see paragraph 2.22). 6 Assets, liabilities, income and expenses are defined in Table 4.1. They are the elements of financial statements. © IFRS Foundation A23 Conceptual Framework Applying the fundamental qualitative characteristics 2.20 Information must both be relevant and provide a faithful representation of what it purports to represent if it is to be useful. Neither a faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant phenomenon helps users make good decisions. 2.21 The most efficient and effective process for applying the fundamental qualitative characteristics would usually be as follows (subject to the effects of enhancing characteristics and the cost constraint, which are not considered in this example). First, identify an economic phenomenon, information about which is capable of being useful to users of the reporting entity’s financial information. Second, identify the type of information about that phenomenon that would be most relevant. Third, determine whether that information is available and whether it can provide a faithful representation of the economic phenomenon. If so, the process of satisfying the fundamental qualitative characteristics ends at that point. If not, the process is repeated with the next most relevant type of information. 2.22 In some cases, a trade-off between the fundamental qualitative characteristics may need to be made in order to meet the objective of financial reporting, which is to provide useful information about economic phenomena. For example, the most relevant information about a phenomenon may be a highly uncertain estimate. In some cases, the level of measurement uncertainty involved in making that estimate may be so high that it may be questionable whether the estimate would provide a sufficiently faithful representation of that phenomenon. In some such cases, the most useful information may be the highly uncertain estimate, accompanied by a description of the estimate and an explanation of the uncertainties that affect it. In other such cases, if that information would not provide a sufficiently faithful representation of that phenomenon, the most useful information may include an estimate of another type that is slightly less relevant but is subject to lower measurement uncertainty. In limited circumstances, there may be no estimate that provides useful information. In those limited circumstances, it may be necessary to provide information that does not rely on an estimate. Enhancing qualitative characteristics 2.23 Comparability, verifiability, timeliness and understandability are qualitative characteristics that enhance the usefulness of information that both is relevant and provides a faithful representation of what it purports to represent. The enhancing qualitative characteristics may also help determine which of two ways should be used to depict a phenomenon if both are considered to provide equally relevant information and an equally faithful representation of that phenomenon. A24 © IFRS Foundation  Conceptual Framework Comparability 2.24 Users’ decisions involve choosing between alternatives, for example, selling or holding an investment, or investing in one reporting entity or another. Consequently, information about a reporting entity is more useful if it can be compared with similar information about other entities and with similar information about the same entity for another period or another date. 2.25 Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items. Unlike the other qualitative characteristics, comparability does not relate to a single item. A comparison requires at least two items. 2.26 Consistency, although related to comparability, is not the same. Consistency refers to the use of the same methods for the same items, either from period to period within a reporting entity or in a single period across entities. Comparability is the goal; consistency helps to achieve that goal. 2.27 Comparability is not uniformity. For information to be comparable, like things must look alike and different things must look different. Comparability of financial information is not enhanced by making unlike things look alike any more than it is enhanced by making like things look different. 2.28 Some degree of comparability is likely to be attained by satisfying the fundamental qualitative characteristics. A faithful representation of a relevant economic phenomenon should naturally possess some degree of comparability with a faithful representation of a similar relevant economic phenomenon by another reporting entity. 2.29 Although a single economic phenomenon can be faithfully represented in multiple ways, permitting alternative accounting methods for the same economic phenomenon diminishes comparability. Verifiability 2.30 Verifiability helps assure users that information faithfully represents the economic phenomena it purports to represent. Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation. Quantified information need not be a single point estimate to be verifiable. A range of possible amounts and the related probabilities can also be verified. 2.31 Verification can be direct or indirect. Direct verification means verifying an amount or other representation through direct observation, for example, by counting cash. Indirect verification means checking the inputs to a model, formula or other technique and recalculating the outputs using the same methodology. An example is verifying the carrying amount of inventory by checking the inputs (quantities and costs) and recalculating the ending inventory using the same cost flow assumption (for example, using the first- in, first-out method). © IFRS Foundation A25 Conceptual Framework 2.32 It may not be possible to verify some explanations and forward-looking financial information until a future period, if at all. To help users decide whether they want to use that information, it would normally be necessary to disclose the underlying assumptions, the methods of compiling the information and other factors and circumstances that support the information. Timeliness 2.33 Timeliness means having information available to decision-makers in time to be capable of influencing their decisions. Generally, the older the information is the less useful it is. However, some information may continue to be timely long after the end of a reporting period because, for example, some users may need to identify and assess trends. Understandability 2.34 Classifying, characterising and presenting information clearly and concisely makes it understandable. 2.35 Some phenomena are inherently complex and cannot be made easy to understand. Excluding information about those phenomena from financial reports might make the information in those financial reports easier to understand. However, those reports would be incomplete and therefore possibly misleading. 2.36 Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information diligently. At times, even well-informed and diligent users may need to seek the aid of an adviser to understand information about complex economic phenomena. Applying the enhancing qualitative characteristics 2.37 Enhancing qualitative characteristics should be maximised to the extent possible. However, the enhancing qualitative characteristics, either individually or as a group, cannot make information useful if that information is irrelevant or does not provide a faithful representation of what it purports to represent. 2.38 Applying the enhancing qualitative characteristics is an iterative process that does not follow a prescribed order. Sometimes, one enhancing qualitative characteristic may have to be diminished to maximise another qualitative characteristic. For example, a temporary reduction in comparability as a result of prospectively applying a new Standard may be worthwhile to improve relevance or faithful representation in the longer term. Appropriate disclosures may partially compensate for non-comparability. A26 © IFRS Foundation  Conceptual Framework The cost constraint on useful financial reporting 2.39 Cost is a pervasive constraint on the information that can be provided by financial reporting. Reporting financial information imposes costs, and it is important that those costs are justified by the benefits of reporting that information. There are several types of costs and benefits to consider. 2.40 Providers of financial information expend most of the effort involved in collecting, processing, verifying and disseminating financial information, but users ultimately bear those costs in the form of reduced returns. Users of financial information also incur costs of analysing and interpreting the information provided. If needed information is not provided, users incur additional costs to obtain that information elsewhere or to estimate it. 2.41 Reporting financial information that is relevant and faithfully represents what it purports to represent helps users to make decisions with more confidence. This results in more efficient functioning of capital markets and a lower cost of capital for the economy as a whole. An individual investor, lender or other creditor also receives benefits by making more informed decisions. However, it is not possible for general purpose financial reports to provide all the information that every user finds relevant. 2.42 In applying the cost constraint, the Board assesses whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use that information. When applying the cost constraint in developing a proposed Standard, the Board seeks information from providers of financial information, users, auditors, academics and others about the expected nature and quantity of the benefits and costs of that Standard. In most situations, assessments are based on a combination of quantitative and qualitative information. 2.43 Because of the inherent subjectivity, different individuals’ assessments of the costs and benefits of reporting particular items of financial information will vary. Therefore, the Board seeks to consider costs and benefits in relation to financial reporting generally, and not just in relation to individual reporting entities. That does not mean that assessments of costs and benefits always justify the same reporting requirements for all entities. Differences may be appropriate because of different sizes of entities, different ways of raising capital (publicly or privately), different users’ needs or other factors. © IFRS Foundation A27 Conceptual Framework CONTENTS from paragraph CHAPTER 3—FINANCIAL STATEMENTS AND THE REPORTING ENTITY FINANCIAL STATEMENTS 3.1 Objective and scope of financial statements 3.2 Reporting period 3.4 Perspective adopted in financial statements 3.8 Going concern assumption 3.9 THE REPORTING ENTITY 3.10 Consolidated and unconsolidated financial statements 3.15 A28 © IFRS Foundation  Conceptual Framework Financial statements 3.1 Chapters 1 and 2 discuss information provided in general purpose financial reports and Chapters 3–8 discuss information provided in general purpose financial statements, which are a particular form of general purpose financial reports. Financial statements7 provide information about economic resources of the reporting entity, claims against the entity, and changes in those resources and claims, that meet the definitions of the elements of financial statements (see Table 4.1). Objective and scope of financial statements 3.2 The objective of financial statements is to provide financial information about the reporting entity’s assets, liabilities, equity, income and expenses8 that is useful to users of financial statements in assessing the prospects for future net cash inflows to the reporting entity and in assessing management’s stewardship of the entity’s economic resources (see paragraph 1.3). 3.3 That information is provided: (a) in the statement of financial position, by recognising assets, liabilities and equity; (b) in the statement(s) of financial performance,9 by recognising income and expenses; and (c) in other statements and notes, by presenting and disclosing information about: (i) recognised assets, liabilities, equity, income and expenses (see paragraph 5.1), including information about their nature and about the risks arising from those recognised assets and liabilities; (ii) assets and liabilities that have not been recognised (see paragraph 5.6), including information about their nature and about the risks arising from them; (iii) cash flows; (iv) contributions from holders of equity claims and distributions to them; and (v) the methods, assumptions and judgements used in estimating the amounts presented or disclosed, and changes in those methods, assumptions and judgements. 7 Throughout the Conceptual Framework, the term ‘financial statements’ refers to general purpose financial statements. 8 Assets, liabilities, equity, income and expenses are defined in Table 4.1. They are the elements of financial statements. 9 The Conceptual Framework does not specify whether the statement(s) of financial performance comprise(s) a single statement or two statements. © IFRS Foundation A29 Conceptual Framework Reporting period 3.4 Financial statements are prepared for a specified period of time (reporting period) and provide information about: (a) assets and liabilities—including unrecognised assets and liabilities— and equity that existed at the end of the reporting period, or during the reporting period; and (b) income and expenses for the reporting period. 3.5 To help users of financial statements to identify and assess changes and trends, financial statements also provide comparative information for at least one preceding reporting period. 3.6 Information about possible future transactions and other possible future events (forward-looking information) is included in financial statements if it: (a) relates to the entity’s assets or liabilities—including unrecognised assets or liabilities—or equity that existed at the end of the reporting period, or during the reporting period, or to income or expenses for the reporting period; and (b) is useful to users of financial statements. For example, if an asset or liability is measured by estimating future cash flows, information about those estimated future cash flows may help users of financial statements to understand the reported measures. Financial statements do not typically provide other types of forward-looking information, for example, explanatory material about management’s expectations and strategies for the reporting entity. 3.7 Financial statements include information about transactions and other events that have occurred after the end of the reporting period if providing that information is necessary to meet the objective of financial statements (see paragraph 3.2). Perspective adopted in financial statements 3.8 Financial statements provide information about transactions and other events viewed from the perspective of the reporting entity as a whole, not from the perspective of any particular group of the entity’s existing or potential investors, lenders or other creditors. Going concern assumption 3.9 Financial statements are normally prepared on the assumption that the reporting entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading. If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements describe the basis used. A30 © IFRS Foundation  Conceptual Framework The reporting entity 3.10 A reporting entity is an entity that is required, or chooses, to prepare financial statements. A reporting entity can be a single entity or a portion of an entity or can comprise more than one entity. A reporting entity is not necessarily a legal entity. 3.11 Sometimes one entity (parent) has control over another entity (subsidiary). If a reporting entity comprises both the parent and its subsidiaries, the reporting entity’s financial statements are referred to as ‘consolidated financial statements’ (see paragraphs 3.15–3.16). If a reporting entity is the parent alone, the reporting entity’s financial statements are referred to as ‘unconsolidated financial statements’ (see paragraphs 3.17–3.18). 3.12 If a reporting entity comprises two or more entities that are not all linked by a parent-subsidiary relationship, the reporting entity’s financial statements are referred to as ‘combined financial statements’. 3.13 Determining the appropriate boundary of a reporting entity can be difficult if the reporting entity: (a) is not a legal entity; and (b) does not comprise only legal entities linked by a parent-subsidiary relationship. 3.14 In such cases, determining the boundary of the reporting entity is driven by the information needs of the primary users of the reporting entity’s financial statements. Those users need relevant information that faithfully represents what it purports to represent. Faithful representation requires that: (a) the boundary of the reporting entity does not contain an arbitrary or incomplete set of economic activities; (b) including that set of economic activities within the boundary of the reporting entity results in neutral information; and (c) a description is provided of how the boundary of the reporting entity was determined and of what constitutes the reporting entity. Consolidated and unconsolidated financial statements 3.15 Consolidated financial statements provide information about the assets, liabilities, equity, income and expenses of both the parent and its subsidiaries as a single reporting entity. That information is useful for existing and potential investors, lenders and other creditors of the parent in their assessment of the prospects for future net cash inflows to the parent. This is because net cash inflows to the parent include distributions to the parent from its subsidiaries, and those distributions depend on net cash inflows to the subsidiaries. © IFRS Foundation A31 Conceptual Framework 3.16 Consolidated financial statements are not designed to provide separate information about the assets, liabilities, equity, income and expenses of any particular subsidiary. A subsidiary’s own financial statements are designed to provide that information. 3.17 Unconsolidated financial statements are designed to provide information about the parent’s assets, liabilities, equity, income and expenses, and not about those of its subsidiaries. That information can be useful to existing and potential investors, lenders and other creditors of the parent because: (a) a claim against the parent typically does not give the holder of that claim a claim against subsidiaries; and (b) in some jurisdictions, the amounts that can be legally distributed to holders of equity claims against the parent depend on the distributable reserves of the parent. Another way to provide information about some or all assets, liabilities, equity, income and expenses of the parent alone is in consolidated financial statements, in the notes. 3.18 Information provided in unconsolidated financial statements is typically not sufficient to meet the information needs of existing and potential investors, lenders and other creditors of the parent. Accordingly, when consolidated financial statements are required, unconsolidated financial statements cannot serve as a substitute for consolidated financial statements. Nevertheless, a parent may be required, or choose, to prepare unconsolidated financial statements in addition to consolidated financial statements. A32 © IFRS Foundation  Conceptual Framework CONTENTS from paragraph CHAPTER 4—THE ELEMENTS OF FINANCIAL STATEMENTS INTRODUCTION 4.1 DEFINITION OF AN ASSET 4.3 Right 4.6 Potential to produce economic benefits 4.14 Control 4.19 DEFINITION OF A LIABILITY 4.26 Obligation 4.28 Transfer of an economic resource 4.36 Present obligation as a result of past events 4.42 ASSETS AND LIABILITIES 4.48 Unit of account 4.48 Executory contracts 4.56 Substance of contractual rights and contractual obligations 4.59 DEFINITION OF EQUITY 4.63 DEFINITIONS OF INCOME AND EXPENSES 4.68 © IFRS Foundation A33 Conceptual Framework Introduction 4.1 The elements of financial statements defined in the Conceptual Framework are: (a) assets, liabilities and equity, which relate to a reporting entity’s financial position; and (b) income and expenses, which relate to a reporting entity’s financial performance. 4.2 Those elements are linked to the economic resources, claims and changes in economic resources and claims discussed in Chapter 1, and are defined in Table 4.1. Table 4.1—The elements of financial statements Item discussed in Element Definition or description Chapter 1 Economic resource Asset A present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Claim Liability A present obligation of the entity to transfer an economic resource as a result of past events. Equity The residual interest in the assets of the entity after deducting all its liabilities. Changes in economic Income Increases in assets, or decreases in liabilities, resources and claims, that result in increases in equity, other than reflecting financial those relating to contributions from holders of performance equity claims. Expenses Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims. Other changes in – Contributions from holders of equity claims, economic resources and and distributions to them. claims – Exchanges of assets or liabilities that do not result in increases or decreases in equity. Definition of an asset 4.3 An asset is a present economic resource controlled by the entity as a result of past events. 4.4 An economic resource is a right that has the potential to produce economic benefits. 4.5 This section discusses three aspects of those definitions: (a) right (see paragraphs 4.6–4.13); (b) potential to produce economic benefits (see paragraphs 4.14–4.18); and A34 © IFRS Foundation  Conceptual Framework (c) control (see paragraphs 4.19–4.25). Right 4.6 Rights that have the potential to produce economic benefits take many forms, including: (a) rights that correspond to an obligation of another party (see paragraph 4.39), for example: (i) rights to receive cash. (ii) rights to receive goods or services. (iii) rights to exchange economic resources with another party on favourable terms. Such rights include, for example, a forward contract to buy an economic resource on terms that are currently favourable or an option to buy an economic resource. (iv) rights to benefit from an obligation of another party to transfer an economic resource if a specified uncertain future event occurs (see paragraph 4.37). (b) rights that do not correspond to an obligation of another party, for example: (i) rights over physical objects, such as property, plant and equipment or inventories. Examples of such rights are a right to use a physical object or a right to benefit from the residual value of a leased object. (ii) rights to use intellectual property. 4.7 Many rights are established by contract, legislation or similar means. For example, an entity might obtain rights from owning or leasing a physical object, from owning a debt instrument or an equity instrument, or from owning a registered patent. However, an entity might also obtain rights in other ways, for example: (a) by acquiring or creating know-how that is not in the public domain (see paragraph 4.22); or (b) through an obligation of another party that arises because that other party has no practical ability to act in a manner inconsistent with its customary practices, published policies or specific statements (see paragraph 4.31). 4.8 Some goods or services—for example, employee services—are received and immediately consumed. An entity’s right to obtain the economic benefits produced by such goods or services exists momentarily until the entity consumes the goods or services. 4.9 Not all of an entity’s rights are assets of that entity—to be assets of the entity, the rights must both have the potential to produce for the entity economic benefits beyond the economic benefits available to all other parties (see paragraphs 4.14–4.18) and be controlled by the entity (see paragraphs © IFRS Foundation A35 Conceptual Framework 4.19–4.25). For example, rights available to all parties without significant cost —for instance, rights of access to public goods, such as public rights of way over land, or know-how that is in the public domain—are typically not assets for the entities that hold them. 4.10 An entity cannot have a right to obtain economic benefits from itself. Hence: (a) debt instruments or equity instruments issued by the entity and repurchased and held by it—for example, treasury shares—are not economic resources of that entity; and (b) if a reporting entity comprises more than one legal entity, debt instruments or equity instruments issued by one of those legal entities and held by another of those legal entities are not economic resources of the reporting entity. 4.11 In principle, each of an entity’s rights is a separate asset. However, for accounting purposes, related rights are often treated as a single unit of account that is a single asset (see paragraphs 4.48–4.55). For example, legal ownership of a physical object may give rise to several rights, including: (a) the right to use the object; (b) the right to sell rights over the object; (c) the right to pledge rights over the object; and (d) other rights not listed in (a)–(c). 4.12 In many cases, the set of rights arising from legal ownership of a physical object is accounted for as a single asset. Conceptually, the economic resource is the set of rights, not the physical object. Nevertheless, describing the set of rights as the physical object will often provide a faithful representation of those rights in the most concise and understandable way. 4.13 In some cases, it is uncertain whether a right exists. For example, an entity and another party might dispute whether the entity has a right to receive an economic resource from that other party. Until that existence uncertainty is resolved—for example, by a court ruling—it is uncertain whether the entity has a right and, consequently, whether an asset exists. (Paragraph 5.14 discusses recognition of assets whose existence is uncertain.) Potential to produce economic benefits 4.14 An economic resource is a right that has the potential to produce economic benefits. For that potential to exist, it does not need to be certain, or even likely, that the right will produce economic benefits. It is only necessary that the right already exists and that, in at least one circumstance, it would produce for the entity economic benefits beyond those available to all other parties. 4.15 A right can meet the definition of an economic resource, and hence can be an asset, even if the probability that it will produce economic benefits is low. Nevertheless, that low probability might affect decisions about what information to provide about the asset and how to provide that information, A36 © IFRS Foundation  Conceptual Framework including decisions about whether the asset is recognised (see paragraphs 5.15–5.17) and how it is measured. 4.16 An economic resource could produce economic benefits for an entity by entitling or enabling it to do, for example, one or more of the following: (a) receive contractual cash flows or another economic resource; (b) exchange economic resources with another party on favourable terms; (c) produce cash inflows or avoid cash outflows by, for example: (i) using the economic resource either individually or in combination with other economic resources to produce goods or provide services; (ii) using the economic resource to enhance the value of other economic resources; or (iii) leasing the economic resource to another party; (d) receive cash or other economic resources by selling the economic resource; or (e) extinguish liabilities by transferring the economic resource. 4.17 Although an economic resource derives its value from its present potential to produce future economic benefits, the economic resource is the present right that contains that potential, not the future economic benefits that the right may produce. For example, a purchased option derives its value from its potential to produce economic benefits through exercise of the option at a future date. However, the economic resource is the present right—the right to exercise the option at a future date. The economic resource is not the future economic benefits that the holder will receive if the option is exercised. 4.18 There is a close association between incurring expenditure and acquiring assets, but the two do not necessarily coincide. Hence, when an entity incurs expenditure, this may provide evidence that the entity has sought future economic benefits, but does not provide conclusive proof that the entity has obtained an asset. Similarly, the absence of related expenditure does not preclude an item from meeting the definition of an asset. Assets can include, for example, rights that a government has granted to the entity free of charge or that another party has donated to the entity. Control 4.19 Control links an economic resource to an entity. Assessing whether control exists helps to identify the economic resource for which the entity accounts. For example, an entity may control a proportionate share in a property without controlling the rights arising from ownership of the entire property. In such cases, the entity’s asset is the share in the property, which it controls, not the rights arising from ownership of the entire property, which it does not control. © IFRS Foundation A37 Conceptual Framework 4.20 An entity controls an economic resource if it has the present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it. Control includes the present ability to prevent other parties from directing the use of the economic resource and from obtaining the economic benefits that may flow from it. It follows that, if one party controls an economic resource, no other party controls that resource. 4.21 An entity has the present ability to direct the use of an economic resource if it has the right to deploy that economic resource in its activities, or to allow another party to deploy the economic resource in that other party’s activities. 4.22 Control of an economic resource usually arises from an ability to enforce legal rights. However, control can also arise if an entity has other means of ensuring that it, and no other party, has the present ability to direct the use of the economic resource and obtain the benefits that may flow from it. For example, an entity could control a right to use know-how that is not in the public domain if the entity has access to the know-how and the present ability to keep the know-how secret, even if that know-how is not protected by a registered patent. 4.23 For an entity to control an economic resource, the future economic benefits from that resource must flow to the entity either directly or indirectly rather than to another party. This aspect of control does not imply that the entity can ensure that the resource will produce economic benefits in all circumstances. Instead, it means that if the resource produces economic benefits, the entity is the party that will obtain them either directly or indirectly. 4.24 Having exposure to significant variations in the amount of the economic benefits produced by an economic resource may indicate that the entity controls the resource. However, it is only one factor to consider in the overall assessment of whether control exists. 4.25 Sometimes one party (a principal) engages another party (an agent) to act on behalf of, and for the benefit of, the principal. For example, a principal may engage an agent to arrange sales of goods controlled by the principal. If an agent has custody of an economic resource controlled by the principal, that economic resource is not an asset of the agent. Furthermore, if the agent has an obligation to transfer to a third party an economic resource controlled by the principal, that obligation is not a liability of the agent, because the economic resource that would be transferred is the principal’s economic resource, not the agent’s. Definition of a liability 4.26 A liability is a present obligation of the entity to transfer an economic resource as a result of past events. 4.27 For a liability to exist, three criteria must all be satisfied: (a) the entity has an obligation (see paragraphs 4.28–4.35); A38 © IFRS Foundation  Conceptual Framework (b) the obligation is to transfer an economic resource (see paragraphs 4.36–4.41); and (c) the obligation is a present obligation that exists as a result of past events (see paragraphs 4.42–4.47). Obligation 4.28 The first criterion for a liability is that the entity has an obligation. 4.29 An obligation is a duty or responsibility that an entity has no practical ability to avoid. An obligation is always owed to another party (or parties). The other party (or parties) could be a person or another entity, a group of people or other entities, or society at large. It is not necessary to know the identity of the party (or parties) to whom the obligation is owed. 4.30 If one party has an obligation to transfer an economic resource, it follows that another party (or parties) has a right to receive that economic resource. However, a requirement for one party to recognise a liability and measure it at a specified amount does not imply that the other party (or parties) must recognise an asset or measure it at the same amount. For example, particular Standards may contain different recognition criteria or measurement requirements for the liability of one party and the corresponding asset of the other party (or parties) if those different criteria or requirements are a consequence of decisions intended to select the most relevant information that faithfully represents what it purports to represent. 4.31 Many obligations are established by contract, legislation or similar means and are legally enforceable by the party (or parties) to whom they are owed. Obligations can also arise, however, from an entity’s customary practices, published policies or specific statements if the entity has no practical ability to act in a manner inconsistent with those practices, policies or statements. The obligation that arises in such situations is sometimes referred to as a ‘constructive obligation’. 4.32 In some situations, an entity’s duty or responsibility to transfer an economic resource is conditional on a particular future action that the entity itself may take. Such actions could include operating a particular business or operating in a particular market on a specified future date, or exercising particular options within a contract. In such situations, the entity has an obligation if it has no practical ability to avoid taking that action. 4.33 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. 4.34 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 © IFRS Foundation A39 Conceptual Framework high likelihood of a transfer, is sufficient reason for concluding that the entity has no practical ability to avoid a transfer. 4.35 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. (Paragraph 5.14 discusses recognition of liabilities whose existence is uncertain.) Transfer of an economic resource 4.36 The second criterion for a liability is that the obligation is to transfer an economic resource. 4.37 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. 4.38 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 paragraphs 5.15–5.17) and how it is measured. 4.39 Obligations to transfer an economic resource include, for example: (a) obligations to pay cash. (b) obligations to deliver goods or provide services. (c) obligations to exchange economic resources with another party on unfavourable terms. Such obligations include, for example, a forward contract to sell an economic resource on terms that are currently unfavourable or an option that entitles another party to buy an economic resource from the entity. (d) obligations to transfer an economic resource if a specified uncertain future event occurs. (e) obligations to issue a financial instrument if that financial instrument will oblige the entity to transfer an economic resource. 4.40 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: (a) settle the obligation by negotiating a release from the obligation; A40 © IFRS Foundation  Conceptual Framework (b) transfer the obligation to a third party; or (c) replace that obligation to transfer an economic resource with another obligation by entering into a new transaction. 4.41 In the situations described in paragraph 4.40, an entity has the obligation to transfer an economic resource until it has settled, transferred or replaced that obligation. Present obligation as a result of past events 4.42 The third criterion for a liability is that the obligation is a present obligation that exists as a result of past events. 4.43 A present obligation exists as a result of past events only if: (a) the entity has already obtained economic benefits or taken an action; and (b) as a consequence, the entity will or may have to transfer an economic resource that it would not otherwise have had to transfer. 4.44 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. 4.45 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 in paragraph 4.31 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. 4.46 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. 4.47 An entity does not yet have a present obligation to transfer an economic resource if it has not yet satisfied the criteria in paragraph 4.43, that is, 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. 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 © IFRS Foundation A41 Conceptual Framework 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 (see paragraphs 4.56–4.58). Assets and liabilities Unit of account 4.48 The unit of account is the right or the group of rights, the obligation or the group of obligations, or the group of rights and obligations, to which recognition criteria and measurement concepts are applied. 4.49 A unit of account is selected for an asset or liability when considering how recognition criteria and measurement concepts will apply to that asset or liability and to the related income and expenses. In 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 individually but measured as part of a portfolio of contracts. For presentation and disclosure, assets, liabilities, income and expenses may need to be aggregated or separated into components. 4.50 If an entity transfers part of an asset or part of a liability, the unit of account may change at that time, so that the transferred component and the retained component become separate units of account (see paragraphs 5.26–5.33). 4.51 A unit of account is selected to provide useful information, which implies that: (a) the information provided about the asset or liability and about any related income and expenses must be relevant. Treating a group of rights and obligations as a single unit of account may provide more relevant information than treating each right or obligation as a separate unit of account if, for example, those rights and obligations: (i) cannot be or are unlikely to be the subject of separate transactions; (ii) cannot or are unlikely to expire in different patterns; (iii) have similar economic characteristics and risks and hence are likely to have similar implications for the prospects for future net cash inflows to the entity or net cash outflows from the entity; or (iv) are used together in the business activities conducted by an entity to produce cash flows and are measured by reference to estimates of their interdependent future cash flows. (b) the information provided about the asset or liability and about any related income and expenses must faithfully represent the substance of the transaction or other event from which they have arisen. Therefore, it may be necessary to treat rights or obligations arising from different sources as a single unit of account, or to separate the A42 © IFRS Foundation  Conceptual Framework rights or obligations arising from a single source (see paragraph 4.62). Equally, to provide a faithful representation of unrelated rights and obligations, it may be necessary to recognise and measure them separately. 4.52 Just as cost constrains other financial reporting decisions, it also constrains the selection of a unit of account. Hence, in selecting a unit of account, it is important to consider whether the benefits of the information provided to users of financial statements by selecting that unit of account are likely to justify the costs of providing and using that information. In general, the costs associated with recognising and measuring assets, liabilities, income and expenses increase as the size of the unit of account decreases. Hence, in general, rights or obligations arising from the same source are separated only if the resulting information is more useful and the benefits outweigh the costs. 4.53 Sometimes, both rights and obligations arise from the same source. For example, some contracts establish both rights and obligations for each of the parties. If those rights and obligations are interdependent and cannot be separated, they constitute a single inseparable asset or liability and hence form a single unit of account. For example, this is the case with executory contracts (see paragraph 4.57). Conversely, if rights are separable from obligations, it may sometimes be appropriate to group the rights separately from the obligations, resulting in the identification of one or more separate assets and liabilities. In other cases, it may be more appropriate to group separable rights and obligations in a single unit of account treating them as a single asset or a single liability. 4.54 Treating a set of rights and obligations as a single unit of account differs from offsetting assets and liabilities (see paragraph 7.10). 4.55 Possible units of account include: (a) an individual right or individual obligation; (b) all rights, all obligations, or all rights and all obligations, arising from a single source, for example, a contract; (c) a subgroup of those rights and/or obligations—for example, a subgroup of rights over an item of property, plant and equipment for which the useful life and pattern of consumption differ from those of the other rights over that item; (d) a group of rights and/or obligations arising from a portfolio of similar items; (e) a group of rights and/or obligations arising from a portfolio of dissimilar items—for example, a portfolio of assets and liabilities to be disposed of in a single transaction; and (f) a risk exposure within a portfolio of items—if a portfolio of items is subject to a common risk, some aspects of the accounting for that portfolio could focus on the aggregate exposure to that risk within the portfolio. © IFRS Foundation A43 Conceptual Framework Executory contracts 4.56 An executory contract is a contract, or a portion of a contract, that is equally unperformed—neither party has fulfilled any of its obligations, or both parties have partially fulfilled their obligations to an equal extent. 4.57 An executory contract establishes a combined right and obligation to exchange economic resources. The right and obligation are interdependent and cannot be separated. Hence, the combined right and obligation constitute a single asset or liability. The entity has an asset if the terms of the exchange are currently favourable; it has a liability if the terms of the exchange are currently unfavourable. Whether such an asset or liability is included in the financial statements depends on both the recognition criteria (see Chapter 5) and the measurement basis (see Chapter 6) selected for the asset or liability, including, if applicable, any test for whether the contract is onerous. 4.58 To the extent that either party fulfils its obligations under the contract, the contract is no longer executory. If the reporting entity performs first under the contract, that performance is the event that changes the reporting entity’s right and obligation to exchange economic resources into a right to receive an economic resource. That right is an asset. If the other party performs first, that performance is the event that changes the reporting entity’s right and obligation to exchange economic resources into an obligation to transfer an economic resource. That obligation is a liability. Substance of contractual rights and contractual obligations 4.59 The terms of a contract create rights and obligations for an entity that is a party to that contract. To represent those rights and obligations faithfully, financial statements report their substance (see paragraph 2.12). In some cases, the substance of the rights and obligations is clear from the legal form of the contract. In other cases, the terms of the contract or a group or series of contracts require analysis to identify the substance of the rights and obligations. 4.60 All terms in a contract—whether explicit or implicit—are considered unless they have no substance. Implicit terms could include, for example, obligations imposed by