THE 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 directly related to financial position and their definition according to the
framework are:
 Asset. 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.

 Liability. 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.

 Equity. Equity is the residual interest in the assets of the entity after deducting all its
liabilities.

The elements directly related to performance and their definition according to the framework
are:
 Income. Income is an increase in economic benefits during the accounting period in the
form of inflows or enhancements of assets or decreases of liabilities that result in increase
in equity, other than those relating to contributions from equity participants.

 Expense. Expense is a decrease in economic benefits during the accounting period in the
form of outflows or depletions of assets or incurrence of liabilities that result in decrease
in equity, other than those relating to distributions to equity participants.

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.

RECOGNITION OF THE ELEMENTS OF FINANCIAL STATEMENTS

Recognition is the process of incorporating in the balance sheet or income statement an item
that meets the definition of an element and satisfies the following criteria for recognition:

 It is probable that any future economic benefit associated with the item will flow to or
from the entity; and
 The item's cost or value can be measured with reliability.

The conceptual framework identifies four main recognition principles based on these general
criteria:

 An asset is recognized in the balance sheet 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.

 A liability is recognized in the balance sheet when it is probable that an outflow of

resources embodying economic benefits will result from the settlement of a present
 obligation and the amount at which the settlement will take place can be measured
reliably.

 Income is recognized in the income statement 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. This means, in effect, that recognition of income occurs
simultaneously with the recognition of increases in assets or decreases in liabilities

 Expenses are recognized 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.
This means, in effect, that recognition of expenses occurs simultaneously with the
recognition of an increase in liabilities or a decrease in assets.

MEASUREMENT OF THE ELEMENTS OF FINANCIAL STATEMENTS

Measurement involves assigning monetary amounts at which the elements of the financial
statements are to be recognized and reported. The Framework acknowledges that a variety of
measurement bases are used today to different degrees and in varying combinations in financial
statements, including:

 Historical cost is the amount of cash or cash equivalent paid or fair value of the
consideration given to acquire an asset at the time of acquisition.

 Current cost is the amount of cash or cash equivalent that would have to be paid if the
same or equivalent asset was acquired currently.

 Net realizable (settlement) value is the amount of cash or cash equivalent that could
currently be obtained by selling the asset in orderly disposal.

 Present (discounted) value is the discounted value of the future net cash inflows that the
asset is expected to generate in the normal course of business.

Historical cost is the measurement basis most commonly used today, but it is usually combined
with other measurement bases. The Framework does not include concepts or principles for
selecting which measurement basis should be used for particular elements of financial statements
or in particular circumstances. The qualitative characteristics do provide some guidance in this
matter.

CONCEPTS OF CAPITAL AND CAPITAL MAINTENANCE

Concepts of Capital

 Financial concept of capital. Capital is synonymous with net assets of the entity. This
is the concept of capital adopted by most entities.

 Physical concept of capital. Capital is regarded as the productive capacity of the entity
based on, for example, units of output per day.
The concepts of capital give rise to the following concepts of capital maintenance:

 Financial capital maintenance. Under this concept, a profit is earned only if the financial
(or money) amount of the net assets at the end of the of the period exceeds the financial
(or money) amount of the net assets at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

 Physical capital maintenance. Under this concept, a profit is earned only if the physical
productive capacity (or operating capability) of the entity (or the resources need to achieve
that capacity) at the end of the period exceeds the physical productive capacity at the
beginning of the period, after excluding any distributions to, and contributions from, owners
during the period.

- - END - -

Source:
1. Financial Accounting Vol.I, First Part, 2016 Edition Valix, Conrado T., Peralta, Jose F. and
Valix, Christian Aris M.
2. The Conceptual Framework for Financial Reporting, IFRS Foundation