Financial Accounting and Reporting Conceptual Framework PDF

# FINANCIAL ACCOUNTING AND REPORTING **CONFRA** - Conceptual Framework **CONFRA.04** The Elements of Financial Statements ## 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 *Contr...

# FINANCIAL ACCOUNTING AND REPORTING **CONFRA** - Conceptual Framework **CONFRA.04** The Elements of Financial Statements ## 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 ## 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 Chapter 1 | Element | Definition or description | | ----------- | ----------- | ----------- | | Economic resource | Asset | A present economic resource controlled by the entity as a result of past events.<br> 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 resources and claims, reflecting | Income |Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims. | | financial performance | 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 economic resources and claims | **-** | Contributions from holders of equity claims, and distributions to them. <br> 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 **(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 paragraphs4.19-4.25). 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 **4.11** another of those legal entities are not economic resources of the reporting entity. 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, 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. **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.