RECOGNITION

•The process of capturing for inclusion in the financial statements an item that
meets the definition of an asset, liability, equity, income or expense.

•Recognition links the elements to the statement of financial position and

statement of financial performance.

•Recognition Criteria states that only items that meet the definition of an asset, a
liability, or an equity are recognized in the statement of financial position. This is
similarly defined for income and expense to financial performance.

POINT OF SALE INCOME RECOGNITION PRINCIPLE

•Income Recognition Principle

•Income shall be recognized when earned. Legal title to the goods passes to the
buyer at the point of sale.

•Legal title entails ownership where significant risks and rewards are received
from the goods.

EXPENSE RECOGNITION PRINCIPLE

•Expenses shall be recognized when incurred.

•Application of Matching Principle. This also has three applications:

a. Cause and Effect Application Principle
-Expense is recognized when the revenue is already recognized on

the basis of a presumed direct association of the expense with

specific revenue.
-Adheres strict matching concept

b. Systematic and Rational Allocation Principle

-Cost are expensed by simply allocating them over period
benefitted.
-This is applied when there is an absence of a direct and clear
association of the expense with specific revenue.
-Concrete examples include depreciation, amortization, and
allocation of prepayments.
 c. Immediate Recognition Principle
-Cost incurred is expensed outright because of uncertainty of future

economic benefits.
-It could also be because of 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.

DERECOGNITION
•The removal of all or part of a recognized asset or liability from the statement of
financial position.

•Normally occurs when an item no longer meets the definition of an asset or

liability

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

•Derecognition of liability occurs when the entity no longer has a present

obligation for all or part of the liability.

MEASUREMENT
•Quantifying in monetary terms the elements in the financial statements

Categories of Measurement

Historical Cost
-Cost of an asset is cost incurred acquiring or creating the asset
comprising the consideration paid plus transaction cost.
-Cost of a liability is the consideration received to incur the liability
minus transaction cost.
 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 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 liability becomes onerous.
c. Accrual of the interest to reflect any financing component of the
liability
d. Amortized cost of measurement of financial liability

Current Value
•Defined into four (4) components:

(1) 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 a liability is the price that would be 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.
-It can be observed directly using market price of the asset or
liability in an active market.
-If this cannot be directly measured, an entity can use present value
of cash flows.

(2) Value in use

-It is the present value of the cash flows that an entity expects to
derive from the continuing use of an asset and from the ultimate
disposal.
 -Does not include transaction cost on acquiring the asset but
includes transaction cost on the disposal of the asset

(3) Fulfillment Value

-It is the present value of cash that an entity expects to transfer in
paying or settling a liability.
-It does not include transaction cost on incurring a liability but
includes transaction cost on fulfillment of a liability.

(4) Current cost

-Current cost or replacement cost of an asset is the cost of an
equivalent asset at the measurement date comprising the
consideration paid and transaction cost.
-Current cost of the liability is the consideration that would be
received less any transaction cost at measurement date.

PRESENTATION AND DISCLOSURE OF FINANCIAL INFORMATION

•The presentation and disclosure can be an effective communication tool about

the information in financial statements.

•Effective communication helps make financial information more relevant and

faithfully represented.

•Effective communication enhances comparability and understandability.

•Duplication is usually unnecessary and can make financial statements less

understandable.

•Presentation and disclosure can be achieved by classification and aggregation

of assets, liabilities, equity, income, and expenses.

Classification as a tool of presentation and disclosure

•Classification is the sorting of assets, liabilities, equity, income, and expenses on

the basis of shared or similar characteristics.

•For example, it could be appropriate to classify an asset or a liability into current
and noncurrent.
•It may be necessary to classify components of equity separately if such
components are subject to legal, regulatory, and other requirements.
 •Thus, ordinary share capital, preference share capital, share premium and
retained earnings should be disclosed separately.

Aggregation of financial information

•Aggregation is the adding together of assets, liabilities, equity, income, and
expenses that have similar or shared characteristics and are included in the
same classification.

•Aggregation makes information more useful by summarizing a large volume of

detail. However, it may conceal some of the detail.

Capital Maintenance Approach

•The financial performance of an entity is determined using two approaches:

A. Transaction Approach
-It is the traditional preparation of an income statement.

B. Capital Maintenance Approach

-The net income occurs only after the capital used from the beginning
of the period is maintained.
-Net income is the amount an entity can distribute to its owners and be
as “well-off” at the end of the year as at the beginning
-Shareholders invest in entity to earn a return on capital or an amount
in excess of their original investment.
-Return of capital is an erosion of capital invested in the entity.

Concepts of Capital Maintenance

•There are two known concepts of capital maintenance or well-offness, namely:

A. Financial Capital Concept

-Capital is synonymous with net assets or equity of the entity.
-Financial Capital is the monetary amount of the net assets contributed

by shareholders.
-This is also the amount of increase in net assets resulting from
earnings retained by the entity.
-It is the traditional concept based on historical cost and adopted by
most entities.

Under the financial capital concept,

“net income occurs when the nominal amount of the net assets
at the end of the year exceeds the nominal amount of the net
assets at the beginning of the period, after excluding
 -Determination of Income under the Financial Capital Concept:

January 1 December 31
Total assets 1,500,000 2,500,000
Total liabilities 1,000,000 1,200,000
Issuance of shares during the year 400,000
Dividends paid during the year 300,000

Computation of net income

Net assets – December 31 1,300,000

Add: Dividends paid 300,000
Total 1,600,000
Less: Net assets – January 1 500,000
Issuance of shares 400,000 900,000
Net income 700,000

Note that the amount of net assets is the excess to total assets over the total liabilities.
This is the reason this approach is also known as the net assets approach.

B. Physical Capital Concept

-Physical capital is the quantitative measure of the physical productive
capacity to produce goods and services.
-This requires that productive assets be measured at current cost,
rather than historical cost.
-Productive assets include inventories and property, plant, and
equipment.
-Physical capital is equal to the net assets of the entity expressed in
terms of current cost.
-This should be adopted if the main concern of users is the operating
ability of the entity, meaning, the resource or fund needed to achieve
that operating capability or capacity.

Under the physical capital concept,

“net income occurs when the physical productive capital of the
entity at the end of the year exceeds the physical productive
capital at the beginning of the period, also after excluding
distributions to and contribution from owners during the
period.”
 -Determination of Income under the Physical Capital Concept:

(Assume in the previously given illustration, the net assets of P500,000 on January 1
has a current cost of P800,000 by reason of inflationary condition.)

Net assets – December 31 1,300,000

Add: Dividends paid 300,000
Total 1,600,000
Less: Net assets at current cost, January 1 800,000
Issuance of shares 400,000 1,200,000
Net income 400,000