GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

(GAAP)

What Are Generally Accepted Accounting Principles (GAAP)?

Generally accepted accounting principles (GAAP) refer to a common set of accounting

principles, standards, and procedures issued by the Financial Accounting Standards
Board (FASB). Public companies in the U.S. must follow GAAP when their accountants
compile their financial statements.

Understanding GAAP

GAAP is a combination of authoritative standards (set by policy boards) and the

commonly accepted ways of recording and reporting accounting information. GAAP aims to
improve the clarity, consistency, and comparability of the communication of financial
information.

GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial
reporting method. Internationally, the equivalent to GAAP in the U.S. is referred to
as International Financial Reporting Standards (IFRS). IFRS is currently used in 166
jurisdictions.

GAAP helps govern the world of accounting according to general rules and guidelines.
It attempts to standardize and regulate the definitions, assumptions, and methods used in
accounting across all industries. GAAP covers such topics as revenue recognition, balance
sheet classification, and materiality.

The ultimate goal of GAAP is to ensure a company's financial statements are

complete, consistent, and comparable. This makes it easier for investors to analyze and extract
useful information from the company's financial statements, including trend data over a
period of time. It also facilitates the comparison of financial information across different
companies.

10 Principles of GAAP

There are 10 general concepts that lay out the main mission of GAAP.
1. Principle of Regularity

The accountant has adhered to GAAP rules and regulations as a standard.

2. Principle of Consistency

Accountants commit to applying the same standards throughout the reporting process, from
one period to the next, to ensure financial comparability between periods. Accountants are
expected to fully disclose and explain the reasons behind any changed or updated standards in
the footnotes to the financial statements.

3. Principle of Sincerity

The accountant strives to provide an accurate and impartial depiction of a company’s financial
situation.

4. Principle of Permanence of Methods

The procedures used in financial reporting should be consistent, allowing a comparison of the
company's financial information.

5. Principle of Non-Compensation

Both negatives and positives should be reported with full transparency and without the
expectation of debt compensation.

6. Principle of Prudence

This refers to emphasizing fact-based financial data representation that is not clouded by
speculation.

7. Principle of Continuity

While valuing assets, it should be assumed the business will continue to operate.

8. Principle of Periodicity

Entries should be distributed across the appropriate periods of time. For example, revenue
should be reported in its relevant accounting period.
9. Principle of Materiality

Accountants must strive to fully disclose all financial data and accounting information in
financial reports.

10. Principle of Utmost Good Faith

Derived from the Latin phrase uberrimae fidei used within the insurance industry. It
presupposes that parties remain honest in all transactions.

Compliance With GAAP

If a corporation's stock is publicly traded, its financial statements must adhere to rules
established by the U.S. Securities and Exchange Commission (SEC). The SEC requires that
publicly traded companies in the U.S. regularly file GAAP-compliant financial statements in
order to remain publicly listed on the stock exchanges.3 GAAP compliance is ensured through
an appropriate auditor's opinion, resulting from an external audit by a certified public
accounting (CPA) firm.

Although it is not required for non-publicly traded companies, GAAP is viewed

favorably by lenders and creditors. Most financial institutions will require annual GAAP-
compliant financial statements as a part of their debt covenants when issuing business loans.
As a result, most companies in the United States do follow GAAP.

If a financial statement is not prepared using GAAP, investors should be cautious.

Without GAAP, comparing financial statements of different companies would be extremely
difficult, even within the same industry, making an apples-to-apples comparison hard. Some
companies may report both GAAP and non-GAAP measures when reporting their financial
results. GAAP regulations require that non-GAAP measures be identified in financial
statements and other public disclosures, such as press releases.

The hierarchy of GAAP is designed to improve financial reporting. It consists of a

framework for selecting the principles that public accountants should use in preparing
financial statements in line with U.S. GAAP. The hierarchy is broken down as follows:

• Statements by the Financial Accounting Standards Board (FASB) and Accounting

Research Bulletins and Accounting Principles Board opinions by the American
Institute of Certified Public Accountants (AICPA)
 • FASB Technical Bulletins and AICPA Industry Audit and Accounting Guides and
Statements of Position

• AICPA Accounting Standards Executive Committee Practice Bulletins, positions of

the FASB Emerging Issues Task Force (EITF), and topics discussed in Appendix D of
EITF Abstracts

• FASB implementation guides, AICPA Accounting Interpretations, AICPA Industry

Audit, and Accounting Guides, Statements of Position not cleared by the FASB, and
accounting practices that are widely accepted and followed

Accountants are directed to first consult sources at the top of the hierarchy and then
proceed to lower levels only if there is no relevant pronouncement at a higher level. The
FASB's Statement of Financial Accounting Standards No. 162 provides a detailed explanation
of the hierarchy.

Special Considerations

GAAP is only a set of standards. Although these principles work to improve the
transparency in financial statements, they do not provide any guarantee that a company's
financial statements are free from errors or omissions that are intended to mislead investors.
There is plenty of room within GAAP for unscrupulous accountants to distort figures. So even
when a company uses GAAP, you still need to scrutinize its financial statements.

Where Are Generally Accepted Accounting Principles (GAAP) Used?

GAAP is a set of procedures and guidelines used by companies to prepare their

financial statements and other accounting disclosures. The standards are prepared by the
Financial Accounting Standards Board (FASB), which is an independent non-profit
organization. The purpose of GAAP standards is to help ensure that the financial information
provided to investors and regulators is accurate, reliable, and consistent with one another.

Why Is GAAP Important?

GAAP is important because it helps maintain trust in the financial markets. If not for
GAAP, investors would be more reluctant to trust the information presented to them by
companies because they would have less confidence in its integrity. Without that trust, we
might see fewer transactions, potentially leading to higher transaction costs and a less robust
economy. GAAP also helps investors analyze companies by making it easier to perform
“apples to apples” comparisons between one company and another.
Acounting Standard
What Is an Accounting Standard?

An accounting standard is a common set of principles, standards, and procedures that

define the basis of financial accounting policies and practices.

Understanding Accounting Standard

Accounting standards improve the transparency of financial reporting in all countries.

In the United States, the Generally Accepted Accounting Principles form the set of accounting
standards widely accepted for preparing financial statements. International companies follow
the International Financial Reporting Standards (IFRS), which are set by the International
Accounting Standards Board and serve as the guideline for non-U.S. GAAP companies
reporting financial statements.

Generally Accepted Accounting Principles are heavily used among public and private entities
in the United States. The rest of the world primarily uses IFRS. Multinational entities are
required to use these standards. The IASB establishes and interprets the international
communities' accounting standards when preparing financial statements.

Accounting standards relate to all aspects of an entity’s finances, including assets,

liabilities, revenue, expenses, and shareholders' equity. Specific examples of an accounting
standard include revenue recognition, asset classification, allowable methods for depreciation,
what is considered depreciable, lease classifications, and outstanding share measurement.

The American Institute of Accountants, which is now known as the American Institute
of Certified Public Accountants, and the New York Stock Exchange attempted to launch the
first accounting standards in the 1930s. Following this attempt came the Securities Act of
1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange
Commission. Accounting standards have also been established by the Governmental
Accounting Standards Board for accounting principles for all state and local governments.

Accounting standards specify when and how economic events are to be recognized,
measured, and displayed. External entities, such as banks, investors, and regulatory agencies,
rely on accounting standards to ensure relevant and accurate information is provided about the
entity. These technical pronouncements have ensured transparency in reporting and set the
boundaries for financial reporting measures.

U.S. GAAP Accounting Standards

The American Institute of Certified Public Accountants developed, managed, and

enacted the first set of accounting standards. In 1973, these responsibilities were given to the
newly created Financial Accounting Standards Board. The Securities and Exchange
Commission requires all listed companies to adhere to U.S. GAAP accounting standards in
the preparation of their financial statements to be listed on a U.S. securities exchange.

Accounting standards ensure the financial statements from multiple companies are
comparable. Because all entities follow the same rules, accounting standards make the
financial statements credible and allow for more economic decisions based on accurate and
consistent information.

Financial Accounting Standards Board (FASB)

An independent nonprofit organization, the Financial Accounting Standards Board

(FASB) has the authority to establish and interpret generally accepted accounting principles
(GAAP) in the United States for public and private companies and nonprofit organizations.
GAAP refers to a set of standards for how companies, nonprofits, and governments should
prepare and present their financial statements.

Why Are Accounting Standards Useful?

Accounting standards improve the transparency of financial reporting in all

countries. They specify when and how economic events are to be recognized, measured, and
displayed. External entities, such as banks, investors, and regulatory agencies, rely on
accounting standards to ensure relevant and accurate information is provided about the entity.
These technical pronouncements have ensured transparency in reporting and set the
boundaries for financial reporting measures.
Accounting Policies
What Are Accounting Policies?

Accounting policies are the specific principles and procedures implemented by a

company's management team that are used to prepare its financial statements. These include
any accounting methods, measurement systems, and procedures for presenting disclosures.
Accounting policies differ from accounting principles in that the principles are the accounting
rules and the policies are a company's way of adhering to those rules.

How Accounting Policies Are Used

Accounting policies are a set of standards that govern how a company prepares its
financial statements. These policies are used to deal specifically with complicated accounting
practices such as depreciation methods, recognition of goodwill, preparation of research and
development (R&D) costs, inventory valuation, and the consolidation of financial accounts.
These policies may differ from company to company, but all accounting policies are required
to conform to generally accepted accounting principles (GAAP) and/or international financial
reporting standards (IFRS).

Accounting principles can be thought of as a framework in which a company is

expected to operate. However, the framework is somewhat flexible, and a company's
management team can choose specific accounting policies that are advantageous to the
financial reporting of the company. Because accounting principles are lenient at times, the
specific policies of a company are very important.

Looking into a company's accounting policies can signal whether management is

conservative or aggressive when reporting earnings. This should be taken into account by
investors when reviewing earnings reports to assess the quality of earnings. Also, external
auditors who are hired to review a company's financial statements should review the
company's policies to ensure they conform to GAAP.

Company management can select accounting policies that are advantageous to their
own financial reporting, such as selecting a particular inventory valuation method.
Accounting Convention

What Is an Accounting Convention?

Accounting conventions are guidelines used to help companies determine how to

record certain business transactions that have not yet been fully addressed by accounting
standards. These procedures and principles are not legally binding but are generally accepted
by accounting bodies. Basically, they are designed to promote consistency and help
accountants overcome practical problems that can arise when preparing financial statements.

Understanding an Accounting Convention

Sometimes, there is not a definitive guideline in the accounting standards that govern a
specific situation. In such cases, accounting conventions can be referred to.

Accounting is full of assumptions, concepts, standards, and conventions. Concepts

such as relevance, reliability, materiality, and comparability are often supported by
accounting conventions that help to standardize the financial reporting process.

In short, accounting conventions serve to fill in the gaps not yet addressed by
accounting standards. If an oversight organization, such as the Securities and Exchange
Commission (SEC) or the Financial Accounting Standards Board (FASB) sets forth a
guideline that addresses the same topic as the accounting convention, the accounting
convention is no longer applicable.

The scope and detail of accounting standards continue to widen, meaning that there are
now fewer accounting conventions that can be used. Accounting conventions are not set in
stone, either. Instead, they can evolve over time to reflect new ideas and opinions on the best
way to record transactions.

Accounting conventions are important because they ensure that multiple different
companies record transactions in the same way. Providing a standardized methodology makes
it easier for investors to compare the financial results of different firms, such as competing
ones operating in the same sector.
 That said, accounting conventions are by no means flawless. They are sometimes
loosely explained, presenting companies and their accountants with the opportunity to
potentially bend or manipulate them to their advantage.

Accounting Convention Methods

There are four main accounting conventions designed to assist accountants:

• Conservatism: Playing it safe is both an accounting principle and convention. It tells

accountants to err on the side of caution when providing estimates for assets and
liabilities. That means that when two values of a transaction are available, the lower
one should be favored. The general concept is to factor in the worst-case scenario of a
firm’s financial future.

• Consistency: A company should apply the same accounting principles across

different accounting cycles. Once it chooses a method it is urged to stick with it in the
future, unless it has a good reason to do otherwise. Without this convention, investors'
ability to compare and assess how the company performs from one period to the next
is made much more challenging.

• Full disclosure: Information considered potentially important and relevant must be

revealed, regardless of whether it is detrimental to the company.

• Materiality: Like full disclosure, this convention urges companies to lay all their cards
on the table. If an item or event is material, in other words important, it should be
disclosed. The idea here is that any information that could influence the decision of a
person looking at the financial statement must be included.

Areas Where Accounting Conventions Apply

Accounting conservatism may be applied to inventory valuation. When determining

the reporting value of inventory, conservatism dictates that the lower of historical cost or
replacement cost should be the monetary value.

Accounting conventions also dictate that adjustments to line items should not be made
for inflation or market value. This means book value can sometimes be less than market
value. For example, if a building costs $50,000 when it is purchased, it should remain on the
books at $50,000, regardless of whether it is worth more now.
 Estimations such as uncollectible accounts receivables and casualty losses also use the
conservatism convention. If a company expects to win a litigation claim, it cannot report the
gain until it meets all revenue recognition principles. However, if a litigation claim is
expected to be lost, an estimated economic impact is required in the notes to the financial
statements. Contingent liabilities such as royalty payments or unearned revenue are to be
disclosed, too.
 ACCOUNTING STANDARDS BOARD
THE CONCEPTUAL FRAMEWORK FOR GENERAL
PURPOSE FINANCIAL REPORTING

Introduction
1. The Conceptual Framework for General Purpose Financial Reporting (the Conceptual
Framework) establishes the concepts that are to be applied in developing Standards of Generally
Recognised Accounting Practice (GRAP) applicable to the preparation and presentation of
general purpose financial statements (GPFSs) of public sector entities.
2. The Conceptual Framework also establishes concepts for the presentation of general purpose
financial reports (GPFRs) which are reported outside the financial statements, and which
complement and supplement the information in the financial statements.
3. The primary objective of most public sector entities is to deliver services to the public, rather
than to make profits and generate a return on equity to investors. Consequently, the performance
of such entities can be only partially evaluated by examination of financial position, financial
performance and cash flows. GPFRs provide information to users for accountability and
decision-making purposes. Therefore, users of the GPFRs of public sector entities need
information to support assessments of such matters as:
• whether the entity provided its services to constituents in an efficient and effective manner;
• the resources currently available for future expenditures, and to what extent there are
restrictions or conditions attached to their use;
• to what extent the burden on future-year taxpayers of paying for current services
has changed; and
• whether the entity’s ability to provide services has improved or deteriorated compared with the
previous year.
4. Government generally has broad powers, including the ability to establish and enforce legal
requirements, and to change those requirements. Governance in the public sector generally
involves the holding to account of the executive by a legislative body (or equivalent).
CHAPTER 1: ROLE AND AUTHORITY OF THE CONCEPTUAL

FRAMEWORK

Role of the Conceptual Framework

1.1 The Conceptual Framework for General Purpose Financial Reporting (the Conceptual
Framework) establishes the concepts that underpin general purpose financial reporting
(financial reporting) by public sector entities that adopt the accrual basis of accounting.

1.2 The role of the Conceptual Framework is to:

(a) provide the Accounting Standards Board (the Board) with a conceptual basis for
developing Standards of Generally Recognised Accounting Practice (GRAP) applicable to the
preparation and presentation of general purpose financial statements (GPFSs) of public sector
entities;

(b) promote the advancement of financial reporting so that the preparation and presentation of
general purpose financial reports (GPFRs) is comprehensive, cohesive and consistent with the
concepts used to prepare and present GPFSs;

(c) assist preparers of GPFSs in applying Standards of GRAP and in dealing with topics that
may not form the subject of a Standard of GRAP;

(d) provide users of GPFSs prepared in accordance with Standards of GRAP such as
Parliament, the legislatures, municipal councils or other relevant authorities, with information
on the basis on which such GPFSs are prepared and to assist them to hold entities accountable
and make decisions;

(e) assist users of GPFSs in interpreting the information contained in GPFSs prepared in
conformity with the Standards of GRAP; and

(f) provide auditors with a framework to form an opinion as to whether financial statements
conform with Standards of GRAP
QUALITATIVE CHARACTERISTICS

Relevance
3.7 Financial and non-financial information is relevant if it is capable of making a difference
in achieving the objectives of financial reporting. Financial and nonfinancial information is
capable of making a difference when it has confirmatory value, predictive value, or both. It
may be capable of making a difference, and thus be relevant, even if some users choose not to
take advantage of it or are already aware of it.

3.8 Financial and non-financial information has confirmatory value if it confirms or changes
past (or present) expectations. For example, information will be relevant for accountability
and decision-making purposes if it confirms expectations about such matters as the extent to
which managers have discharged their responsibilities for the efficient and effective use of
resources, the achievement of specified service delivery objectives, and compliance with
relevant budgetary, legislative and other requirements.

3.9 GPFRs may present information about an entity’s anticipated future service delivery
activities, objectives and costs, and the amount and sources of the resources that are intended
to be allocated to providing services in the future. Such future oriented information will have
predictive value and be relevant for accountability and decision making purposes. Information
about economic and other phenomena that exist or have already occurred can also have
predictive value in helping form expectations about the future. For example, information that
confirms or disproves past expectations can reinforce or change expectations about financial
results and service delivery outcomes that may occur in the future.

3.10 The confirmatory and predictive roles of information are interrelated ― for example,
information about the current level and structure of an entity’s resources and claims to those
resources helps users to confirm the outcome of resource management strategies during the
period, and to predict an entity’s ability to respond to changing circumstances and anticipated
future service delivery needs. The same information helps to confirm or correct users’ past
expectations and predictions about the entity’s ability to respond to such changes. It also
helps to confirm or correct prospective financial information included in previous GPFRs.
Materiality

3.11 The relevance of information is affected by its nature and materiality. In some cases, the
nature of information alone is sufficient to determine its relevance. For example, the reporting
of a new programme or service segment may affect the assessment of the risks and
opportunities facing the entity irrespective of the materiality of the results achieved by the
new segment in the reporting period. In other cases, both the nature and materiality are
important, for example, the amounts of inventories held in each of the main categories that are
appropriate to the entity.

3.12 Information is material if its omission or misstatement could influence the discharge of
accountability by the entity, or the decisions that users make on the basis of the entity’s
GPFRs prepared for that reporting period. Materiality depends on both the nature and amount
of the item judged in the particular circumstances of each entity. GPFRs may encompass
qualitative and quantitative information about service delivery achievements during the
reporting period, and expectations about service delivery and financial outcomes in the future.
Consequently, it is not possible to specify a uniform quantitative threshold at which a
particular type of information becomes material.

3.13 Assessments of materiality will be made in the context of the legislative, institutional
and operating environment within which the entity operates and, in respect of prospective
financial and non-financial information, the preparer’s knowledge and expectations about the
future. Disclosure of information about compliance or noncompliance with legislation,
supporting regulations or similar means may be material because of its nature, irrespective of
the magnitude of any amounts involved. In determining whether an item is material in these
circumstances, consideration will be given to such matters as the nature, legality, sensitivity
and consequences of past or anticipated transactions and events, the parties involved in any
such transactions and the circumstances giving rise to them.

3.14 In developing Standards of GRAP, the Board will consider the materiality of the
consequences of applying a particular accounting policy, basis of preparation or presentation
of a particular item or type of information. Subject to the requirements of any Standard of
GRAP, entities preparing GPFRs will also consider the materiality of, for example, the
application of a particular basis of preparation or presentation of particular items of
information.

Faithful representation
3.15 To be useful in financial reporting, information must be a faithful representation of the

economic and other phenomena that it purports to represent. Faithful representation is

attained when the depiction of the phenomenon is complete, neutral, and free from material
error. Information that faithfully represents an economic or other phenomenon depicts the
substance of the underlying transaction, other event, activity or circumstance ― which is not
necessarily always the same as its legal form.

3.16 In practice, it may not be possible to know or confirm whether information presented in
GPFRs is complete, neutral, and free from material error. However, information should be as
complete, neutral, and free from material error as is possible.

3.17 An omission of some information can cause the representation of an economic or other
phenomenon to be false or misleading, and thus not useful to users of GPFRs. For example, a
complete depiction of the item “plant and equipment” in GPFRs will include a numeric
representation of the aggregate amount of plant and equipment together with other
quantitative, descriptive and explanatory information necessary to faithfully represent that
class of assets. In some cases, this may include the disclosure of information about such
matters as the major classes of plant and equipment, factors that have affected their use in the
past or might impact on their use in the future, and the basis and process for determining their
numeric representation. Similarly, prospective financial and non- financial information and
information about the achievement of service delivery objectives and outcomes included in
GPFRs will need to be presented with the key assumptions that underlie that information and
 any explanations that are necessary to ensure that its depiction is complete and useful to users.

3.18 Neutrality in financial reporting is the absence of bias. It means that the selection and
presentation of financial and non-financial information is not made with the intention of
attaining a particular predetermined result ― for example, to influence in a particular way
users’ assessment of the discharge of accountability by the entity or a decision or judgement
that is to be made, or to induce particular behaviour.

3.19 Neutral information faithfully represents the economic and other phenomena that it
purports to represent. However, to require information included in GPFRs to be neutral does
not mean that it is not without purpose or that it will not influence behaviour. Relevance is a
qualitative characteristic and, by definition, relevant information is capable of influencing
users’ assessments and decisions.

3.20 The economic and other phenomena represented in GPFRs generally occur under
conditions of uncertainty. Information included in GPFRs will therefore often include
estimates that incorporate management’s judgement. To faithfully represent an economic or
other phenomenon, an estimate must be based on appropriate inputs, and each input must
reflect the best available information. Caution will need to be exercised when dealing with
uncertainty. It may sometimes be necessary to explicitly disclose the degree of uncertainty in
financial and non-financial information to faithfully represent economic and other
phenomena.

3.21 Free from material error does not mean complete accuracy in all respects. Free from
material error means there are no errors or omissions that are individually or collectively
material in the description of the phenomenon, and the process used to produce the reported
information has been applied as described. In some cases, it may be possible to determine the
accuracy of some information included in GPFRs ― for example, the amount of a cash
transfer to another level of government, the volume of services delivered or the price paid for
the acquisition of plant and equipment. However, in other cases it may not ― for example,
the accuracy of an estimate of the value or cost of an item or the effectiveness of a service
delivery programme may not be able to be determined. In these cases, the estimate will be
free from material error if the amount is clearly described as an estimate, the nature and
limitations of the estimation process are explained, and no material errors have been
identified in selecting and applying an appropriate process for developing the estimate.

ELEMENTS IN FINANCIAL STATEMENTS

Introduction

Elements and their importance

5.2 Financial statements portray the financial effects of transactions and other events by
grouping them into broad classes which share common economic characteristics. These broad
classes are termed the elements of financial statements. Elements are the building blocks from
which financial statements are constructed. These building blocks provide an initial point for
recording, classifying and aggregating economic data and activity in a way that provides users
with information that meets the objectives of financial reporting and achieves the qualitative
characteristics of financial reporting while taking into account the constraints on information
included in GPFRs.
5.3 The elements defined in this Chapter do not refer to the individual items that are recognised
as a result of transactions and events. Sub-classifications of individual items within an element
and aggregations of items are used to enhance the understandability of the financial statements.
Presentation is addressed in Chapter 8, Presentation in General Purpose Financial Reports.
Elements defined
5.4 The elements that are defined in this Chapter are:
• assets;
• liabilities;
• revenue;
• expense;
• ownership contributions; and
• ownership distributions.
Assets
Definition
5.5 An asset is:
A resource presently controlled by the entity as a result of a past event.
A resource
5.6 A resource is an item with service potential or the ability to generate economic benefits.
Physical form is not a necessary condition of a resource. The service potential or ability to
generate economic benefits can arise directly from the resource itself, from the rights to use the
resource or the entity’s ability to direct how it may be used by denying or restricting access to
that resource. Some resources embody an entity’s rights to a variety of benefits including, for
example, the right to:
• use the resource to provide services;
• use an external party’s resources to provide services, for example, leases;
• convert the resource into cash through its disposal;
• benefit from the resource’s appreciation in value; or
• receive a stream of cash flows.

5.7 Service potential is the capacity to provide services that contribute to achieving the entity’s
objectives. Service potential enables an entity to achieve its objectives without necessarily
generating net cash inflows.

5.8 Public sector assets that embody service potential may include recreational, heritage,
community, defence and other assets which are held by government and public sector entities,
and which are used to provide services to third parties. Such services may be for collective or
individual consumption. Many services may be provided in areas where there is no market
competition or limited market competition. The use and disposal of such assets may be
restricted as many assets that embody service potential are specialised in nature.

5.9 Economic benefits are cash inflows or a reduction in cash outflows. Cash inflows (or
reduced cash outflows) may be derived from, for example:
• an asset’s use in the production and sale of services; or
• the direct exchange of an asset for cash or other resources.

Presently controlled by the entity

5.10 An entity must have control of the resource. Control of the resource entails the ability of
the entity to use the resource (or direct other parties on its use) so as to derive the benefit of the
service potential or economic benefits embodied in the resource in the achievement of its service
delivery or other objectives.
5.11 In assessing whether it presently controls a resource, an entity assesses whether the
following indicators of control exist:
• legal ownership;
• access to the resource, or the ability to deny or restrict access to the resource;
• the means to ensure that the resource is used to achieve its objectives; and
• the existence of an enforceable right to service potential or the ability to generate economic
benefits arising from a resource.

While these indicators are not conclusive determinants of whether control exists, identification
and analysis of them can inform that decision.
Past event
5.12 The definition of an asset requires that a resource that an entity presently controls must
have arisen from a past transaction or other past event. The past transactions or other events that
result in an entity gaining control of a resource and therefore an asset may differ. Entities can
obtain assets by purchasing them in an exchange transaction or developing them. Assets may
also arise through non-exchange transactions, including through the exercising of sovereign
powers. The power to tax or to issue licences and to access or restrict or deny access to the
benefits embodied in intangible resources, like the electromagnetic spectrum, are examples of
public sector-specific powers and rights that may give rise to assets. In assessing when an
entity’s control of rights to resources arise the following events may be considered:
• a general ability to establish a power;
• establishment of a power through a statute;
• exercising the power to create a right; and
• the event which gives rise to the right to receive resources from an external party. An asset
arises when the power is exercised and the rights exist to receive resources.

Liabilities

Definition
5.13 A liability is:
A present obligation of the entity for an outflow of resources3 that results from a past
event.
A present obligation
5.14 Public sector entities can have a number of obligations. A present obligation is a legally
binding obligation (legal obligation) or non-legally binding obligation, which an entity has little
or no realistic alternative to avoid. Obligations are not present obligations unless they are
binding and there is little or no realistic alternative to avoid an outflow of resources.
An outflow of resources from the entity
5.15 A liability must involve an outflow of resources from the entity for it to be settled. An
obligation that can be settled without an outflow of resources from the entity is not a liability.
Past event
5.16 To satisfy the definition of a liability, it is necessary that a present obligation arises as a
result of a past transaction or other event and requires an outflow of resources from the entity.
The complexity of public sector programmes and activities means that a 3 A resource is an item
with service potential or the ability to generate economic benefits number of events in the
development, implementation and operation of a particular programme may give rise to
obligations. For financial reporting purposes it is necessary to determine whether such
commitments and obligations, including binding obligations that the entity has little or no
realistic alternative to avoid but are not legally enforceable (non-legally binding obligations) are
present obligations and satisfy the definition of a liability. Where an arrangement has a legal
form and is binding, such as a contract, the past event may be straightforward to identify. In
other cases, it may be more difficult to identify the past event and identification involves an
assessment of when an entity has little or no realistic alternative to avoid an outflow of
resources from the entity. In making such an assessment an entity considers all the relevant
factors.
Legal and non-legally binding obligations
5.17 Binding obligations can be legal obligations or non-legally binding obligations. Binding
obligations can arise from both exchange and non-exchange transactions. An obligation must be
to an external party in order to give rise to a liability. An entity cannot be obligated to itself,
even where it has publicly communicated an intention to behave in a particular way.
Identification of an external party is an indication of the existence of an obligation giving rise to
a liability. However, it is not essential to know the identity of the external party before the time
of settlement in order for a present obligation and a liability to exist.

5.18 Many arrangements that give rise to an obligation include settlement dates. The inclusion
of a settlement date may provide an indication that an obligation involves an outflow of
resources and gives rise to a liability. However, there are many agreements that do not contain
settlement dates. The absence of a settlement date does not preclude an obligation giving rise to
a liability.

Legal obligations
5.19 A legal obligation is enforceable in law. Such enforceable obligations may arise from a
variety of legal constructs. Exchange transactions are usually contractual in nature and therefore
enforceable through the laws of contract or equivalent authority or arrangements. For some
types of non-exchange transactions, judgement will be necessary to determine whether an
obligation is enforceable in law. Where it is determined that an obligation is enforceable in law
there can be no doubt that an entity has no realistic alternative to avoid the obligation and that a
liability exists.
5.20 Some obligations related to exchange transactions are not strictly enforceable by an
external party at the reporting date, but will be enforceable with the passage of time without the
external party having to meet further conditions — or having to take any further action — prior
to settlement. Claims that are unconditionally enforceable subject to the passage of time are
enforceable obligations in the context of the definition of a liability.
5.21 Sovereign power is the ultimate authority of government to make, amend and repeal legal
provisions. Sovereign power is not a rationale for concluding that an obligation does not meet
the definition of a liability in this Conceptual Framework. The legal position should be assessed
at each reporting date to consider if an obligation is no longer binding and does not meet the
definition of a liability.
Non-legally binding obligations
5.22 Liabilities can arise from non-legally binding obligations. Non-legally binding obligations
differ from legal obligations in that the party to whom the obligation exists cannot take legal (or
equivalent) action to enforce settlement. Non-legally binding obligations that give rise to
liabilities have the following attributes:
• the entity has indicated to other parties by an established pattern of past practice, published
policies, or a sufficiently specific current statement that it will accept certain responsibilities;
• as a result of such an indication, the entity has created a valid expectation on the part of those
other parties that it will discharge those responsibilities; and • the entity has little or no realistic
alternative to avoid settling the obligation arising from those responsibilities.
5.23 In the public sector, obligations may arise at a number of points. For example, in
implementing a programme or service:
• making a political promise such as an electoral pledge;
• announcement of a policy;
• introduction (and approval) of the budget (which may be two distinct points); and
• the budget becoming effective.
The early stages of implementation are unlikely to give rise to present obligations that
meet the definition of a liability. Later stages, such as claimants meeting the eligibility
criteria for the service to be provided, may give rise to obligations that meet the
definition of a liability.
5.24 The point at which an obligation gives rise to a liability depends on the nature of the
obligation. Factors that are likely to impact on judgements whether other parties can validly
conclude that the obligation is such that the entity has little or no realistic alternative to avoid an
outflow of resources include:
• the nature of the past event or events that give rise to the obligation. For example, a promise
made in an election is unlikely to give rise to a present obligation because an electoral pledge
very rarely creates a valid expectation on the part of external parties that the entity has an
obligation that it has little or no realistic alternative to avoid settling. However, an
announcement in relation to an event or circumstance that has occurred may have such political
support that the government has little option to withdraw. Where the government has committed
to introduce and secure passage of the necessary budgetary provision such an announcement
may give rise to a non-legally binding obligation; and
• the ability of the entity to modify or change the obligation before it crystallises. For example,
the announcement of policy will generally not give rise to a nonlegally binding obligation, if it
can be modified before being implemented. Similarly, if an obligation is contingent on future
events occurring, there may be discretion to avoid an outflow of resources before those events
occur.
5.25 “Economic coercion”, “political necessity” or other circumstances may give rise to
situations where, although the public sector entity is not legally obliged to incur an outflow of
resources, the economic or political consequences of refusing to do so are such that the entity
may have little or no realistic alternative to avoid an outflow of resources. Economic coercion,
political necessity or other circumstances may lead to a liability arising from a non-legally
binding obligation.
Net financial position
5.26 Net financial position is the difference between assets and liabilities recognised in the
statement of financial position. Net financial position can be a positive or negative residual
amount.
Revenue and expense
Definitions
5.27 Revenue is:
Increases in the net financial position of the entity, other than increases arising from ownership
contributions.
5.28 Expense is:
Decreases in the net financial position of the entity, other than decreases arising from
ownership distributions.
5.29 Revenue and expense arise from exchange and non-exchange transactions, other events
such as unrealised increases and decreases in the value of assets and liabilities, and the
consumption of assets through depreciation and erosion of service potential and ability to
generate economic benefits through impairments. Revenue and expense may arise from
individual transactions or groups of transactions.
Surplus or deficit for the period
5.30 The entity’s surplus or deficit for the period is the difference between revenue and expense
reported on the statement of financial performance.
Ownership contributions and ownership distributions
Definitions
5.31 Ownership contributions are:
Inflows of resources to an entity, contributed by external parties in their capacity as owners,
which establish, maintain or increase an interest in the net financial position of the entity.
5.32 Ownership distributions are:
Outflows of resources from the entity, distributed to external parties in their capacity as owners,
which return or reduce an interest in the net financial position of the entity.
5.33 It is important to distinguish inflows of resources from owners, including those inflows that
initially establish the ownership interest on creation of the entity as well as those made
subsequently and outflows of resources to owners in their capacity as owners from revenue and
expense. An entity is required to first identify who the owners of the entity are before it can
distinguish the nature of the inflows and outflows relating to the owners. In addition to the
injections of resources and the payment of dividends or similar distributions that may occur it is
relatively common for assets and liabilities to be transferred between public sector entities.
Where such transfers satisfy the definitions of ownership contributions or ownership
distributions they will be accounted for as such.
5.34 Ownership interests may arise on the creation of an entity when another entity contributes
resources to provide the new entity with the capacity to commence operational activities. In the
public sector, contributions to, and distributions from, entities are sometimes linked to the
restructuring of government and will take the form of transfers of assets and liabilities rather
than cash transactions. Ownership interests may take different forms, which may not be
evidenced by an equity instrument.
5.35 Ownership contributions may take the form of an initial injection of resources at the
creation of an entity or a subsequent injection of resources, including those where an entity is
restructured. Ownership distributions may be:
• a return on investment;
• a full or partial return of investment; or
• in the event of the entity being wound up or restructured, a return of any residual
resources.
CHAPTER 6: RECOGNITION IN FINANCIAL STATEMENTS
Recognition criteria and their relationship to disclosure
6.1 This chapter identifies the criteria that must be satisfied in order for an element to be
recognised in the financial statements. Recognition is the process of incorporating and including
in amounts displayed on the face of the appropriate financial statement an item that meets the
definition of an element and can be measured in a way that achieves the qualitative
characteristics and takes account of the constraints on information included in GPFRs.
6.2 The recognition criteria are that:
• an item satisfies the definition of an element; and
• can be measured in a way that achieves the qualitative characteristics and takes account of
constraints on information in GPFRs.
6.3 All items that satisfy the recognition criteria are recognised in the financial statements.
6.4 Recognition involves an assessment of uncertainty related to the existence and measurement
of the element. The conditions that give rise to uncertainty, if any, can change. Therefore, it is
important that uncertainty is assessed at each reporting date.
Definition of an element
6.5 In order to be recognised as an element an item must meet the definition of one of the
elements in Chapter 5. Uncertainty about the existence of an element is addressed by
considering the available evidence in order to make a neutral judgement about whether an item
satisfies all essential characteristics of the definition of that element, taking into account all
available facts and circumstances at the reporting date.

Measurement uncertainty
6.7 In order to recognise an item in the financial statements, it is necessary to attach a monetary
value to the item. This entails choosing an appropriate measurement basis and determining
whether the measurement of the item achieves the qualitative characteristics, taking into account
the constraints on information in GPFRs, including that the measurement is sufficiently relevant
and faithfully representative for the item to be recognised in the financial statements. The
selection of an appropriate measurement basis is considered in Measurement of Assets and
Liabilities in Financial Statements.

6.8 There may be uncertainty associated with the measurement of many amounts presented in
the financial statements. The use of estimates is an essential part of the accrual basis of
accounting. A decision about the relevance and faithful representativeness of measurement
involves the consideration of techniques, such as using ranges of outcomes and point estimates,
and whether additional evidence is available about economic circumstances that existed at the
reporting date. Disclosures can provide useful information on estimation techniques employed.
There may be rare instances in which the level of uncertainty in a single point estimate is so
large that the relevance and faithful representativeness of the measure is questionable even if
disclosures are provided to explain estimation techniques. Under these circumstances the item is
not recognised.
Disclosure and recognition
6.9 The failure to recognise items that meet the definition of an element and the recognition
criteria is not rectified by the disclosure of accounting policies, notes or other explanatory detail.
However, disclosure can provide information about items that meet many, but not all the
characteristics of the definition of an element. Disclosure can also provide information on items
that meet the definition of an element but cannot be measured in a manner that achieves the
qualitative characteristics sufficiently to meet the objectives of financial reporting. Disclosure is
appropriate when knowledge of the item is considered to be relevant to the evaluation of the net
financial position of the entity and therefore meets the objectives of financial reporting.
Unit of account
6.10 The unit of account is the group of rights, the group of obligations or the group of rights
and obligations, to which recognition and measurement requirements are applied.
6.11 A unit of account is selected for an asset or a liability after considering how recognition
and measurement will apply, not only to that asset or liability, but also to the related revenue
and expenses. The selected unit of account may need to be aggregated or disaggregated for
display or disclosure purposes.
6.12 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).
Derecognition
6.13 Derecognition is the process of evaluating whether changes have occurred since the
previous reporting date that warrant removing an element that has been previously recognised
from the financial statements, and removing the item if such changes have occurred. In
evaluating uncertainty about the existence of an element the same criteria are used for
derecognition as at initial recognition.

Measurement bases and their selection

7.5 It is not possible to identify a single measurement basis that best meets the measurement
objective at a Conceptual Framework level. Therefore, the Conceptual Framework does not
propose a single measurement basis (or combination of bases) for all transactions, events and
conditions. It provides guidance on the selection of a measurement basis for assets and liabilities
in order to meet the measurement objective.
7.6 The following measurement bases for assets are identified and discussed in terms of the
information they provide about the cost of services delivered by an entity, the operating capacity
of an entity and the financial capacity of an entity, and the extent to which they provide
information that meets the qualitative characteristics:
Historical cost measurement
• historical cost;
Current value measurements

• market value;
• replacement cost;
• net selling price; and

• value in use.
7.7 The following measurement bases for liabilities are identified and discussed in terms of (a)
the information they provide about the cost of services delivered by an entity, the operating
capacity of an entity and the financial capacity of an entity; and (b) the extent to which they
provide information that meets the qualitative characteristics:
Historical cost measurement
• historical cost;
Current value measurements
• cost of fulfilment;
• market value;
• cost of release; and
• assumption price.

Presentation of Financial Statements

Presentation of Financial Statements states that a complete set of
financial statements comprises:
 a statement of financial position
 either
– a statement of profit or loss and other comprehensive income, or
– a statement of profit or loss plus a statement showing other
comprehensive income
 a statement of changes in equity
 a statement of cash flows
 accounting policies and explanatory notes.