Lecture Wk 4: Recognition of Financial Statement Elements:



Recognition Reqs:

  1. Past event must have given entity control of resource or created present obligation (asset or liability);

  2. Must be probable that that future economic benefits flow into or out of entity from this; &

  3. Amount must be able to be measured reliably (faithful, supportable estimate).


Defs:

According to Contractual Framework (CF)

Assets:

  • Def: present economic resource controlled by entity due to past events. Resource is a right that has potential to produce economic benefits;

  • Right: established by contract, ownership or legislation → obligation for another party to do something;

  • Potential to produce economic benefit: self explanatory

  • Control: self explanatory


Liabilities:

  • Def: present obligation of entity to transfer an economic resource as result of prior events;

  • Present Obligation: enforceable/unavoidable obligation;

  • Past events: receiving future benefit and obligation as a result;

  • Potential for future transferal: self explanatory


Income:

  • Increase in equity; or 

  • Decrease in liabilities; except for

  • Those relating to contributions from holders of equity claims


Expenses:

  • Converse of income;

  • Except for those relating to distributions to holders of equity claims


Common lines for elements:


Current Assets:

  • Details ec benefits attached to asset;

  • Expected to be realised within coming reporting period (usually 12 months); including

  • Cash and cash equivalents: cash or anything which can be reasonably liquidated w/o serious expenses

  • Receivables: anticipated payments from customers;

  • Inventory: (input materials & trade goods)

  • Prepaid expenses: advance payment from creditors


Non-current Assets:

  • Same as current but realised beyond reporting period (generally >12 months);

  • PPE (Property Plants & Equipment): (land, buildings, machines, etc.);

  • Intangible assets: non physical (e.g. patents, trademarks, softwares, etc.);

  • Long term investments: (e.g. stocks, bonds, real estate);

  • Right-of-use assets: self explanatory;

  • Natural resources; &

  • Goodwill (only if acquired)


Intangible Resources:

  • I.e stuff w/o physical substance;

  • E.g: Skills, brand reputation, human capital (value of person in work sense)

  • Many types often don’t show up on FS

  • Allowed to recognise (under AASB 138/IAS 38):

→ Externally acquired: (e.g. acquiring new companies) “Goodwill”;

→ Development costs: Internally generated work knowledge from Research and Dev (R&D) (must have prototype);

→ Internally generated software: specifically related to customisation and/or optimisation of base programs

  • Internally generated goodwill, customer lists, mastheads, brands, publishing titles are not allowed to be recognised


Current Liabilities:

  • Expected to be resolved w/in reporting period;

  • Trade and other payables: (anticipated payments to suppliers/vendors due to credit purchases);

  • Borrowings: debt funding req interest payment;

  • Deferred revenue: ec benefit received but goods/services yet to be provided;

  • Provisions: liabilities w/ more relatively uncertain timing 

  • Lease liabilities: obligations related to lease contracts

NC Liabilities:

  • All same categories as C Liabilities  but beyond the reporting period 


Income

  • Revenue: Income arising from ordinary entity activities; &

  • Other Income: anything else (e.g. royalties, fees, interest, rent);


Expense:

  • Cost of sales (for the relevant period);

  • Other expenses: anything else;

  • Typically classified by nature of expense and/or function\


Owners & Equity:

  • Contributed equity: capital from owner and/or shareholders;

  • Retained earnings: total Σ of net profit/losses since inception of net payment to shareholders;

  • Accumulated other comprehensive income: income on some transactions where income hasn’t been realised yet;

  • Reserves: record amounts set aside from profits or accounting adjustments;

  • Note: reserves are not automatically cash or other liquid funds


Practice Transactions:


  1. $1000 inventory sold on credit w/ 30 day repayment term. Goods delivered today & control transfers to customers:


Receivables. Assets increase 1000, no change in liabilities, equity increases 1000


  1. 30 days later and customer has repaid:


Revenue. No change in assets from before, no change in liabilities from before, no change in equity from before


  1. Business purchases $600 of stationaries in cash


Inventory. Assets decrease by 600, no change in liabilities, equity decrease by 600.

Note: Even though stationary is an asset, stationary will likely be used up during reporting period and will likely not have its economic benefit potential realised.



Judgement in Recognition:


Expensing vs Capitalising:

  • Capitalise: (a cost), record cost as asset on balance sheet; instead of

  • Charging straight to net loss/profit;

  • Recognition decision req judgement;

  • Consider the following scenario:

→ Company A carries out work on its office. (1) Some walls are repainted and a few broken tiles replaced; additionally, (2) it replaces the whole heating system and upgrades electrical wiring.

  • Transaction (1) is expensed  and transaction (2) is capitalised

  • Transaction 1 provides no potential economic benefits afterwards, transaction 2 does (potentially increased quality, function life, reduced need for or cost of maintenance services later)



Provision vs contingent liability:


  • Provisions: liabilities w/ uncertain timing or amount;

  • Contingent liability: not recognised as a liability as either:

→ Possible obligation (unconfirmed existence yet);

→ Do not meet recognition criteria



Activity: Provision or contingent:

  • A company sold a batch of consumer heaters last year. A fault causes overheating.

  • Five customers have complained and sued. Court action is possible. External lawyers say the chances of the company having to pay are about 45–55% depending on evidence that will come out in discovery.

  • Management has previously settled similar claims in most cases, but this time they have publicly said they will defend the suits

  • Possible settlement amounts (based on lawyers’ range): between $100,000 and $600,000. Payment would be in about 12–18 months.


→ Cost of hiring lawyers is provision (depending on win or loss);

→ Settlement is contingent