Elements of financial statements

Assets, liabilities, and equity, which relate to a reporting entity’s financial position; and
Income and expenses, which relate to a reporting entity’s financial performance.

Income (Conceptual Framework 4.68) is ‘increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions for holders of equity claims.’

For example, in the normal operations of a for-profit company, sales will generally result in an inflow of the asset, cash, into the business.

For example, if a company purchases property for $1500000 and sells it one year later for $2,000,000, the gain on the sales of the asset is an enhancement of the asset.

For example in repaying a loan, less is owed to the creditor, thus reducing the amount of the liability.

Any income transaction will result in an increase in equity. This relates to the accounting equation of Assets minus Liabilities equals Equity. If assets or liabilities are altered – as in the definition above – then equity will increase.’

For example, if the company shareholders contribute $1,000,000 cash or the company issued more shares, this will not be regarded as income.

Both revenue and gains.

Arises in the course of ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.

Represent other items that meet the definition of income and may, or may not, arise in the course of the ordinary activities of an entity. Gains represent increases in economic benefits and as such are no different in nature from revenue. Hence, they are not regarded as constituting a separate event.

Expenses (Conceptual Framework 4.69) are ‘decreases in assets, increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.’ Examples of expenses include cost of sales, interest paid, office supplies, salaries and petrol.

For example, each time an expense is paid, such as $3000 phone bill, the payment has consumed $3000 of economic benefits. It is an outflow of an asset because the $3000 payment has resulted in a reduction of cash.

For example, when taking out a loan the company is incurring a liability.

Expense transactions decrease equity. Whenever an asset decreases, this results in equity decreasing as Equity = Assets – Liabilities. If assets or liabilities are altered then equity will decrease.

For example, if the company members receive $50,000 in dividends, this is not an expense.

Losses represent decreases in economic benefits and as such they are no different in nature from other expenses. Hence, they are not regarded as a separate element in this Framework. Losses include, for example, those resulting from disasters such as fire or flood, as well as those arising on the disposal of non-current assets.

The definition of expenses also includes unrealized losses, for example, those arising from the effects of increases in the rate of exchange for a foreign currency in respect of the borrowings of an entity in that currency.

Assets (Conceptual Framework Table 4.1) is ‘a present economic resources controlled by the entity as a result of past events.’ Examples of assets includes cash, stock/inventory, motor vehicle and debt owed to the company by a debtor.

An economic resource is defined as ‘a right that has the potential to produce economic benefits.’ (Conceptual Framework 4.3).

Right
Potential to produce economic benefits
Control by the entity

A ‘right’ corresponds to the obligation of another party or entity. This include the right to receive cash or goods or services, or the right to receive goods and services, the right to exchange economic resources that are favourable to both parties, for example the option to buy an economic resource.

Future economic benefits might be the potential for cash to be earned from products produced by a piece of machinery or from the goods delivered by a vehicle.

For example, possession of the asset in a lockable factory building where access is restricted is a form of control over the asset.

A liability (Conceptual Framework Table 4.26) is ‘a present obligation of the entity to transfer an economic resource as a result of past events.’ Examples of liabilities include a mortgage on a building, a loan, and amount owed to creditor.

Entity obligation
Transfer of economic resource
Existence of a past event

For example, a written loan document requiring monthly repayments is an obligation that exists now (something is owed).

Resources such as cash can be paid, thus forming an outflow of economic benefits from the company.

For example, a signed and dated invoice evidences a transactions.

Equity (Conceptual Framework 4.63) is ‘the residual interest in the assets of the entity after deducting all its liability.’ Equity is always defined in relation to other elements of the financial statements.

The AASB Conceptual Framework (5.6) states that ‘only items that meet the definition of an asset, a liability or equity are recognized in the statement of financial position. Similarly, only items that meet the definition of income or expenses are recognized in the statement(s) of financial performance. However, not all items that meet the definition of one of those elements are recognized.’

Determine whether it is an element by checking the definition of an asset, liability, income or expense.
Test whether the element meets the recognition criteria. For example, just because something can be defined as an asset does not mean it is automatically included in the Balance Sheet. The asset must also meet the recognition criteria.

‘it is uncertain whether or not the asset or liability exists,’ or
‘it may exist, but the probability of an inflow or outflow of economic benefits is low.’