CHAPTER 6: CONCEPTUAL FRAMEWORK - RECOGNITION AND MEASUREMENT

RECOGNITION

The Revised Conceptual Framework defines recognition as the process of capturing for inclusion in the financial
statements an item that meets the definition of an asset, liability, equity, income or expense.

The amount at which an asset, a liability or equity is recognized in the statement of financial position is reported as
carrying amount.

Recognition links the elements to the statement of financial position and statement of financial performance.

The statements are linked because the recognition of an item in one statement requires the recognition of the same
item in another statement.

For example, the recognition of income happens simultaneously with the recognition of an increase in asset or decrease
in liability.

The recognition of expense happens simultaneously with the recognition of a decrease in asset or increase in liability.

Recognition criteria

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 expense are recognized in the statement of financial
performance.

In addition to meeting the definition of an element, items are recognized only when their recognition provides users of
financial statements with information that is both relevant and faithfully represented.

Recognition does not focus anymore on how probable economic benefits will flow to or from the entity and that the cost
can be measured reliably.

An asset or liability and any corresponding income or expense can exist even if the probability of inflow or outflow of the
benefits is low.

Point of sale income recognition

The basic principle of income recognition us that income shall be recognized when earned.

But the question is when is income considered to be earned?

With respect to sale of goods in the ordinary course of business, the point of sale is unquestionably the point of income
recognition.

The reason is that it is at the point of sale that the entity has transferred to the buyer the significant risks and rewards of
ownership of the goods.

Stated differently, legal title to the goods passes to the buyer at the point of sale.

However, under certain conditions, income may be recognized at the point of production, during production and at the
point of collection,

Expense recognition

The basic expense recognition means that expenses are recognized when incurred.

But the question is when are expenses incurred?

Actually, the expense recognition principle is the application of the matching principle.
CHAPTER 6: CONCEPTUAL FRAMEWORK - RECOGNITION AND MEASUREMENT
The generation of revenue is not without any cost. There has got to be some cost in earning a revenue:

“There is no gain if there is no pain”.

The matching principle requires that those costs and expenses incurred in earning a revenue shall be reported in the
same period.

The matching principle has three applications, namely:

a. Cause and effect association.

b. Systematic and rational allocation
c. Immediate recognition

Cause and effect association

Under this principle, the expense is recognized when the revenue is already recognized.

The reason is the presumed direct association of the expense with specific items of income This is actually the “strict
matching concept”.

This process, commonly referred to as the matching of cost, with revenue, involves the simultaneous or combined
recognition of revenue and expenses that result directly and jointly from the same transactions or events.

The best example is the cost of merchandise inventory.

Such cost is considered as an asset in the meantime that the merchandise is on hand.

When the merchandise is sold, the cost thereof is expensed in the form of “cost of goods sold” because at such time
revenue may be recognized.

Other examples include doubtful accounts, warranty expense and sales commissions.

Systematic and rational allocation

Under this principle, some costs are expensed by simply allocating them over the periods benefitted.

The reason for this principle is that the cost incurred will benefit future periods and that there is an absence of a direct
or clear association of the expense with specific revenue.

When economic benefits are expected to arise over several accounting periods and the association with income can only
be broadly or indirectly determined, expenses are recognized on the basis of systematic and allocation procedures.

Concrete examples include depreciation of property, plant and equipment, amortization of intangibles, and allocation of
prepaid rent, insurance and other prepayments.

Immediate recognition

Under this principle, the cost incurred is expensed outright because of uncertainty of future economic benefits or
difficulty of reliably associating certain costs with future revenue.

An expense is recognized immediately:

a. When an expenditure produces no future economic benefit.

b. When cost incurred does not qualify or ceases to qualify for recognition as an asset.

Examples include officers’ salaries and most administrative expenses, advertising and most selling expenses, amount to
settle lawsuit and worthless intangibles.
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Many losses, such as loss from disposal of building, loss from sale of investments, and casualty loss, are immediately
recognized because they are not directly related to specific revenue.

Derecognition

The Revised Conceptual Framework introduced the term derecognition.

Derecognition is defined as the removal of all or part of a recognized asset or liability from the statement of financial
position.

Derecognition normally occurs when an item no longer meets the definition of an asset or a liability.

Derecognition of an asset occurs when the entity loses control of all or part of the asset.

Derecognition of a liability occurs when the entity no longer as a present obligation for all or part of the liability.

MEASUREMENT

Measurement is defined as quantifying in monetary terms the elements in the financial statements.

The Revised Conceptual Framework mentions two categories:

a. Historical cost
b. Current value

HISTORICAL COST

The historical cost of an asset is the cost incurred in acquiring or creating the asset comprising the consideration paid
plus transaction cost.

The historical cost of a liability is the consideration received to incur the lability minus transaction cost.

Simply stated, historical cost is the entry price or entry value to acquire an asset or to incur a liability.

An application of the historical cost measurement is to measure financial asset and financial liability at amortized cost.

The amortized cost reflects the estimate of future cash flows discounted at a rate determined at initial recognition.

Historical cost updated

1. Historical cost of an asset is updated because of:

a. Depreciation and amortization
b. Payment received as a result of disposing part or all of the asset
c. Impairment
d. Accrual of interest to reflect any financing component of the asset
e. Amortized cost measurement of financial asset
2. Historical cost of a liability is updated because of:
a. Payment made or satisfying an obligation to deliver goods
b. Increase in value of the obligation to transfer economic resources such that the liability becomes onerous
c. Accrual of interest to reflect any financing component of the liability
d. Amortized cost measurement of financial liability

CURRENT VALUE

Current value includes:

a. Fair value
b. Value in use for asset
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c. Fulfillment value for liability
d. Current cost

Fair value

Fair value of an asset is the price that would be received to sell an asset in an orderly transaction between market
participants at measurement date.

Fair value of liability is the price that would paid to transfer a liability in an orderly transaction between market
participants at the measurement date.

Fair value is an exit price or exit value.

Fair value can be observed directly using market price of the asset or lability in an active market.

In cases where fair value cannot be ‘directly measured, an entity can use present value of cash flows.

Fair value is not adjusted for transaction cost. The reason is that such cost is a characteristic of the transaction and not
of the asset or liability.

Value in use

Value in use is the present value of the cash flows that an entity expects to derive from the use of an asset and from the
ultimate disposal.

Value in use does not include transaction cost on acquiring the asset but includes transaction cost on the disposal of the
asset.

Value in use is an exit price or exit value.

Fulfillment value

Fulfillment value is the present value of cash that an entity expects to transfer in paying or settling a liability.

Fulfillment value does not include transaction cost on incurring a liability but includes transaction cost on fulfillment of a
liability.

Fulfillment value is an exit price or exit value.

Current cost

Current cost of an asset is the cost of an equivalent asset at the measurement date comprising the consideration paid
ang transaction cost.

Current cost of a liability is the consideration that would be received less any transaction cost at measurement date.

Similar to historical cost, current cost is also based on the entry price or entry value but reflects market conditions on
measurement date.

Selecting a measurement basis

In selecting a measurement basis for an asset or a liability and for the related income and expense, it is necessary to
consider the nature of the information that the measurement basis will produce.

In most cases, no single factor will determine which measurement basis should be selected.

The relative importance of each factor will depend on facts and circumstances.

The information produced by the measurement basis must be useful to the users of financial statements.
CHAPTER 6: CONCEPTUAL FRAMEWORK - RECOGNITION AND MEASUREMENT
To achieve this, the information must be both relevant and faithfully represented.

Historical cost is the measurement basis most commonly adopted in preparing financial statements.

In many situations, it is simpler and less costly to measure historical cost than it is to measure a current value.

In addition, historical cost is generally well understood and verifiable.

The IASB did not mandate a single measurement basis because the different measurement bases could produce useful
information under different circumstances.