CHAPTER 5: CONCEPTUAL FRAMEWORK – Elements of Financial Statements

Elements of Financial Statements

Financial statements portray the financial effects of transactions and other events by grouping them into
broad classes according to their economic characteristics.

These broad classes are termed the elements of financial statements.

The elements of financial statements refer to the quantitative information reported in the statement of
financial position and income statement.

The elements of financial statements are the “building blocks” from which financial statements are
constructed.

The elements directly related to the measurement of financial position are:

a) Asset
b) Liability
c) Equity

The elements directly related to the measurement of financial performance are:

a) Income
b) Expense

The Conceptual Framework identifies no elements that are unique to the statement of changes in equity
because such statement comprises items that appear in the statement of financial position and the
income statement.

Asset

Under the Revised Conceptual Framework, an asset is defined as 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.

The new definition clarifies that an asset is an economic resource and that the potential economic
benefits no longer need to be expected to flow to the entity.

Essential characteristics of asset

a) The asset is a present economic resource.

b) The economic resource is a right that has the potential to produce economic benefits.
c) The economic resource is controlled by the entity as a result of past events.

Right

Rights that have the potential to produce economic benefits may take the following forms:

a) Rights that correspond to an obligation of another entity

 b) Rights that do not correspond to an obligation of another entity
c) Right established by contract or legislation

Potential to produce economic benefits

An economic resource is a right that has the potential to produce economic benefits.

The economic resource is the present right that contains the potential and not the future economic
benefits that the right may produce.

An economic resource could produce economic benefits if an entity is entitled:

a) To receive contractual cash flows

b) To exchange economic resources with another party on favorable terms
c) To produce cash inflows or avoid cash outflows
d) To receive cash by selling the economic resource
e) To extinguish a liability by transferring an economic resource

Control of an economic resource

An entity controls an asset if it has the present ability to direct the use of the assets and obtain the
economic benefits that flow from it.

Control also includes the ability to prevent others from using such asset and therefore preventing others
from obtaining the economic benefits from the asset.

Control may arise if an entity enforces legal rights.

Liability

Under the Revised Conceptual Framework, a liability is defined as present obligation of an entity to
transfer an economic resource as a result of past events.

The new definition clarifies that a liability is the obligation to transfer an economic resource and not the
ultimate outflow of economic benefits.

The outflow of economic benefits no longer needs to be expected similar to the definition of an asset.

Essential characteristics of liability

a) The entity has an obligation.

b) The obligation is to transfer an economic resource.
c) The obligation is a present obligation that exists as a result of past event.

Obligation

An obligation is a duty or responsibility that an entity has no practical ability to avoid. Obligations can
either be legal or constructive.

Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement.

This is normally the case, for example, with accounts payable for goods and services received.
Constructive obligations arise from normal business practice, custom and a desire to maintain good
business relations or act in an equitable manner.

For example, an entity decides as a matter of policy to rectify faults in the products even when these
become apparent after the warranty period.

Transfer of an economic resource

Obligation to transfer an economic resource include:

a) Obligation to pay cash

b) Obligation to deliver goods or noncash resources
c) Obligation to provide services at some future time
d) Obligation to exchange economic resources with another party on unfavorable terms
e) Obligation to transfer an economic resource if specified uncertain future event occurs

Past event

An obligation exists as a result of past event if both of the following conditions are satisfied:

a) An entity has already obtained economic benefits.

b) An entity must transfer an economic resource.

Definition of income

Income is defined as increases in assets or decreases in liabilities that result in increases in equity, other
than those relating to contributions from equity holders.

The definition of income encompasses both revenue and gains.

Revenue arises in the course of the ordinary regular activities and is referred to by variety of different
names including sales, fees, interest, dividends, royalties and rent. The essence of revenue is regularity.

Gains represent other items that meet the definition of income and do not arise in the course of the
ordinary regular activities.

Gains include gain from disposal of noncurrent asset, unrealized gain on trading investment and gain
from expropriation.

Statement of financial performance

This statement refers to the statement of profit and loss and a statement presenting other
comprehensive income.

The statement of profit or loss is the primary source of information about an entity’s financial
performance. As a general rule, all income and expenses are included in profit or loss.

Definition of expense

Expense is defined as decreases in assets or increases in liabilities that result in decreases in equity, other
than those relating to distributions to equity holders.
Expenses encompass losses as well as those expenses that arise in the course of the ordinary regular
activities.

Expenses that arise in the course of ordinary regular activities include cost of goods sold, wages and
depreciation.

Losses do not arise in the course of the ordinary regular activities and include losses resulting from
disasters.

Examples include losses from fire, flood, storm surge, tsunami and hurricane, as well as those arising
from disposal of noncurrent assets.
MULTIPLE CHOICE THEORIES

1. The elements directly related to the measurement of financial position are

a. Assets, liabilities, equity, income and expense

b. Assets, liabilities and equity
c. Income and expenses
d. Assets and liabilities

2. The elements directly related to the measurement of financial performance are

a. Assets, liabilities, equity, income and expense

b. Assets, liabilities and equity
c. Income and expenses
d. Sales and cost of goods sold

3. It is a decrease in economic benefit during the accounting period related to a decrease in asset or an
increase in liability that results in decrease in equity other than distribution to owners.

a. Asset c. Income
b. Liability d. Expense

4. Which statement in relation to income is true?

a. Income encompasses both revenue and gain.

b. Revenue encompasses both income and gain.
c. Gain encompasses both income and revenue.
d. Income is the same as revenue.

5. This arises in the course of ordinary regular activities and is referred to by a variety of different names
including sales, fees, interest, dividends, royalties and rent.

a. Income c. Profit
b. Revenue d. Gain