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Definition of an asset and recognition criteria
Extract from FRS102: Section 2.15(a), Section 2.17-2.19, Section 2.29 and Section 2.37-2.38
2.15 The financial position of an entity is the relationship of its assets, liabilities and equity as of a specific date as presented in the statement of financial position. These are defined as follows:
(a) An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
2.17 The future economic benefit of an asset is its potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the entity. Those cash flows may come from using the asset or from disposing of it.
2.18 Many assets, for example property, plant and equipment, have a physical form. However, physical form is not essential to the existence of an asset. Some assets are intangible.
2.19 In determining the existence of an asset, the right of ownership is not essential. Thus, for example, property held on a lease is an asset if the entity controls the benefits that are expected to flow from the property.
2.29 The concept of probability is used in the first recognition criterion to refer to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence relating to conditions at the end of the reporting period available when the financial statements are prepared. Those assessments are made individually for individually significant items, and for a group for a large population of individually insignificant items.
Recognition criteria
2.37 An entity shall recognise an asset in the statement of financial position when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. An asset is not recognised in the statement of financial position when expenditure has been incurred for which it is considered not probable that economic benefits will flow to the entity beyond the current reporting period. Instead such a transaction results in the recognition of an expense in the statement of comprehensive income (or in the income statement, if presented).
2.38 An entity shall not recognise a contingent asset as an asset. However, when the flow of future economic benefits to the entity is virtually certain, then the related asset is not a contingent asset, and its recognition is appropriate.
OmniPro comment
The above definition identifies what an asset is, it does not provide guidance on whether it should be recognised or not. To summarise an asset is:
- A resource controlled by an entity; and
- It has an ability to derive future economic benefits in the form of cash or cash equivalents; and
An asset is only recognised on the balance sheet if:
- It is probable (i.e. more likely than not) that the economic benefits will flow to the entity except for contingent assets
- Contingent assets should only be recognised when it is virtually certain. They should only be disclosed if the right to future economic benefits it probable. If they are remote no disclosure is required.
Examples with regard to contingent assets are included in Section 21 (Provisions) of this website.
Definition of a liability and recognition criteria
Extract from FRS102: Section 2.15(b), Section 2.17, Section 2.20-2.21, Section 2.29. Section 2.31-2.32 and Section 2.39-2.40
2.15 The financial position of an entity is the relationship of its assets, liabilities and equity as of a specific date as presented in the statement of financial position. These are defined as follows:
(b) A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
2.16 Some items that meet the definition of an asset or a liability may not be recognised as assets or liabilities in the statement of financial position because they do not satisfy the criteria for recognition in paragraphs 2.27 to 2.32. In particular, the expectation that future economic benefits will flow to or from an entity must be sufficiently certain to meet the probability criterion before an asset or liability is recognised.
2.20 An essential characteristic of a liability is that the entity has a present obligation to act or perform in a particular way. The obligation may be either a legal obligation or a constructive obligation. A legal obligation is legally enforceable as a consequence of a binding contract or statutory requirement. A constructive obligation is an obligation that derives from an entity’s actions when:
(a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept certain responsibilities; and
(b) as a result, the entity has created a valid expectation on the part of those other parties that it will discharge those responsibilities.
2.21 The settlement of a present obligation usually involves the payment of cash, transfer of other assets, provision of services, the replacement of that obligation with another obligation, or conversion of the obligation to equity. An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights.
Recognition criteria
2.39 An entity shall recognise a liability in the statement of financial position when:
(a) the entity has an obligation at the end of the reporting period as a result of a past event;
(b) it is probable that the entity will be required to transfer resources embodying economic benefits in settlement; and
(c) the settlement amount can be measured reliably.
2.40 A contingent liability is either a possible but uncertain obligation or a present obligation that is not recognised because it fails to meet one or both of the conditions
(b) and (c) in paragraph 2.39. An entity shall not recognise a contingent liability as a liability, except for contingent liabilities of an acquiree in a business combination (see Section 19 Business Combinations and Goodwill).
2.29 The concept of probability is used in the first recognition criterion to refer to the degree of uncertainty that the future economic benefits associated with the item will flow to or from the entity. Assessments of the degree of uncertainty attaching to the flow of future economic benefits are made on the basis of the evidence relating to conditions at the end of the reporting period available when the financial statements are prepared. Those assessments are made individually for individually significant items, and for a group for a large population of individually insignificant items.
2.31 An item that fails to meet the recognition criteria may qualify for recognition at a later date as a result of subsequent circumstances or events.
2.32 An item that fails to meet the criteria for recognition may nonetheless warrant disclosure in the notes or explanatory material or in supplementary schedules. This is appropriate when knowledge of the item is relevant to the evaluation of the financial position, performance and changes in financial position of an entity by the users of financial statements.
OmniPro comment
The above definition is in line with the guidance provided in Section 21-Provisions. A liability exists where:
- There is a present obligation (which is either constructive or legal) as a result of a past event;
A liability will be measured in the balance sheet if it meets the above criteria but also:
- It is probable (i.e. more likely than not) that future economic benefits will be payable; and
- It can be reliably measured.
Where a liability is possible or it is probable but cannot be reliably measured it should be disclosed as a contingent liability. Example 5 is the application of the above guidance is provided in Section 21.
Definition of Equity
Extract from FRS102: Section 2.15(c) and Section 2.22
2.15 The financial position of an entity is the relationship of its assets, liabilities and equity as of a specific date as presented in the statement of financial position. These are defined as follows:
(c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.
2.22 Equity is the residual interest in the assets of the entity after deducting all its liabilities. It may be sub-classified in the statement of financial position. For example, in a corporate entity, sub-classifications may include funds contributed by shareholders, retained earnings and gains or losses recognised in other comprehensive income.
OmniPro comment
Equity is in effect anything that is shown in the statement of changes in equity. Section 22 of this website discusses equity in further detail.
Definition and recognition of Income/revenue
Extract from FRS102: Section 2.23(a), Section 2.25 and Section 2.41
2.23(a) Income is increases in economic benefits during the reporting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity investors.
2.25 The definition of income encompasses both revenue and gains.
(a) Revenue is income that arises in the course of the ordinary activities of an entity and is referred to by a variety of names including sales, fees, interest, dividends, royalties and rent.
(b) Gains are other items that meet the definition of income but are not revenue. When gains are recognised in the statement of comprehensive income, they are usually displayed separately because knowledge of them is useful for making economic decisions.
2.41 The recognition of income results directly from the recognition and measurement of assets and liabilities. An entity shall recognise income in the statement of comprehensive income (or in the income statement, if presented) when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.
OmniPro comment
Whether an item is shown as turnover/revenue in the financial statements or instead other income is driven by what the entity’s main ordinary activities are.
Example 1: Turnover/revenue versus other income
An entity who is in the business of buying and selling goods, would classify that income in the turnover line of the financial statements. If that same entity also generates income from the rental of investment properties which is incidental to its main trade, this would not be shown within turnover/revenue instead it would be disclosed as other income on the face of the profit and loss and an explanation provided in the notes where material detailing that it is rental income.
The same would be the case if that entity had some income from the dividends on investments, this would not be shown in the turnover line.
Example 2: Turnover/revenue versus other income
If we take another entity whose business involves the purchase of land and development of properties on this land which includes in certain instances the holding of some of these properties for future rental as investment properties. In this case the sale of the land and properties to third parties would be shown as revenue. In addition, the rental income would be classified as revenue/turnover as this is also part of its business. A note would be required to show the split of income in the financial statements.
Example 3: Turnover/revenue versus other income
Company A is involved in the holdings of investments. In this case dividend income, gains on sale of shares would be shown in revenue in the profit and loss account.
Revenue recognition rules are dependent on when the risks and reward of ownership transfer. This is discussed further in Section 23.
Definition and recognition of expenses
Extract from FRS102: Section 2.23(b), Section 2.26 and Section 2.42
2.23(b) Expenses are decreases in economic benefits during the reporting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity investors.
2.26 The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity.
(a) Expenses that arise in the course of the ordinary activities of the entity include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, or property, plant and equipment.
(b) Losses are other items that meet the definition of expenses and may arise in the course of the ordinary activities of the entity. When losses are recognised in the statement of comprehensive income, they are usually presented separately because knowledge of them is useful for making economic decisions.
2.42 The recognition of expenses results directly from the recognition and measurement of assets and liabilities. An entity shall recognise expenses in the statement of comprehensive income (or in the income statement, if presented) when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.
OmniPro comment
From the above guidance, it is clear that anything that involves distributions to shareholders are not expenses e.g. a dividend paid to a shareholder is not an expense however a salary paid to the director is an expense.
An expense is recognised when a liability is created on the balance sheet i.e. when it is probable that it will be incurred.
Measurement of assets, liabilities, income and expenses
Extract from FRS102: Section 2.33-.2.34
2.33 Measurement is the process of determining the monetary amounts at which an entity measures assets, liabilities, income and expenses in its financial statements. Measurement involves the selection of a basis of measurement. This FRS specifies which measurement basis an entity shall use for many types of assets, liabilities, income and expenses.
2.34 Two common measurement bases are historical cost and fair value:
(a) For assets, historical cost is the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire the asset at the time of its acquisition.
For liabilities, historical cost is the amount of proceeds of cash or cash equivalents received or the fair value of non-cash assets received in exchange for the obligation at the time the obligation is incurred, or in some circumstances (for example, income tax) the amounts of cash or cash equivalents expected to be paid to settle the liability in the normal course of business.
Amortised historical cost is the historical cost of an asset or liability plus or minus that portion of its historical cost previously recognised as an expense or income.
(b) Fair value is the amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged, between knowledgeable, willing parties in an arm’s length transaction. In the absence of any specific guidance provided in the relevant section of this FRS, where fair value measurement is permitted or required the guidance in paragraphs 11.27 to 11.32 shall be applied.
OmniPro comment
Whether the historical cost method or the fair value method is applied depends on the rules in each section of FRS 102. Each of these measurement methods are discussed in great detail in each relevant section of this manual.
In general, assets and liabilities are initially measured at historical cost unless there is a specific requirement elsewhere in the FRS to measure them at fair value. Subsequent measurement depends on the type of balance and will be based on one of the following:
- Amortised cost (for most basic financial assets and liabilities)
- Fair value (for other financial assets and liabilities, investments in associates and joint ventures (if chosen), investment properties, and some agricultural assets)
- The cost model or revaluation model (for property, plant and equipment and intangible assets)
- The lower of cost and selling price less costs to complete and sell (for inventory)
- The best estimate of the amount that would be required to settle the obligation at the reporting date (for most non-financial liabilities)
Pervasive recognition and measurement principles
Extract from FRS102: Section 2.35
2.35 The requirements for recognising and measuring assets, liabilities, income and expenses in this FRS are based on pervasive principles that are derived from the IASB Framework for the Preparation and Presentation of Financial Statements and from EU-adopted IFRS. In the absence of a requirement in this FRS that applies specifically to a transaction or other event or condition, paragraph 10.4 provides guidance for making a judgement and paragraph 10.5 establishes a hierarchy for an entity to follow in deciding on the appropriate accounting policy in the circumstances. The second level of that hierarchy requires an entity to look to the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses and the pervasive principles set out in this section.
OmniPro comment
It is clear that an entity must select an accounting policy where a choice arises and disclose all material accounting policies in the notes to the financial statements.
Accrual basis
Extract from FRS102: Section 2.36
2.36 An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. On the accrual basis, items are recognised as assets, liabilities, equity, income or expenses when they satisfy the definitions and recognition criteria for those items.
OmniPro comment
The accruals basis should be utilised. This basis ensures that costs are matched with revenues and that costs incurred in the period even where not invoiced are included in the results for that period.
Recognition in financial statements
Extract from FRS102: Section 2.43-2.45
Total comprehensive income and profit or loss
2.43 Total comprehensive income is the arithmetical difference between income and expenses. It is not a separate element of financial statements, and a separate recognition principle is not needed for it.
2.44 Profit or loss is the arithmetical difference between income and expenses other than those items of income and expense that this FRS classifies as items of other comprehensive income. It is not a separate element of financial statements, and a separate recognition principle is not needed for it.
2.45 Generally this FRS does not allow the recognition of items in the statement of financial position that do not meet the definition of assets or of liabilities regardless of whether they result from applying the notion commonly referred to as the ‘matching concept’ for measuring profit or loss.
OmniPro comment
Section 2.45 does not permit the use of the matching concept if the asset and liability do not meet the recognition criteria.
The requirements with regard to the other comprehensive income are dealt with in Section 5 of this website. Any income or expenses recognised in OCI are those that are mandated by each section of FRS 102. Examples of items to be included in OCI are:
- Revaluation of property, plant and equipment net of deferred tax
- Revaluation of intangible assets net of deferred tax
- Remeasurement of defined benefit liability obligations net of deferred tax
- Movements in and out of the cash flow hedge reserve
- Foreign exchange gains/loss on the retranslation of foreign operations in the consolidated financial statements.
Offsetting
Extract from FRS102: Section 2.52
2.52 An entity shall not offset assets and liabilities, or income and expenses, unless required or permitted by an FRS.
(a) Measuring assets net of valuation allowances (for example, allowances for inventory obsolescence and allowances for uncollectible receivables) is not offsetting.
(b) If an entity’s normal operating activities do not include buying and selling fixed assets, including investments and operating assets, then the entity reports gains and losses on disposal of such assets by deducting from the proceeds on disposal the carrying amount of the asset and related selling expenses.
OmniPro comment
The rules on offsetting are dealt with in each relevant section of FRS 102 and have been disclosed in each relevant section of this manual. The general rule is that:
- Offsetting should only occur where there is a legal right of offset.
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