Accounting Business Reporting for Decision Making

CHAPTER 5 Balance sheet 169

5.7 Assets, liabilities and equity

LEARNING OBJECTIVE 5.7 Apply the recognition criteria to assets, liabilities and equity.

Only items that meet the definition of an asset, a liability or equity can be recognised in the balance

sheet and, as will be discussed in chapter 7, only items that meet the definition of income or expenses

can be recognised in the statement of financial performance. The term recognition refers to recording

items in the financial statements with a monetary value assigned to them. Therefore, ‘asset recognition’

or ‘liability recognition’ means that the asset or liability is recorded and appears on the face of the bal-

ance sheet with its amount included in totals in the relevant statement. Central to the recognition prin-

ciple is that items can be measured in monetary terms. This is referred to as the monetary concept. As

money is the language used to quantify items recognised in the financial statements, if items cannot be

assigned a monetary value, then they cannot appear on the balance sheet.

It is recognition that links the elements in financial statements — assets, liabilities, equity, income and

expenses — and hence the financial statements. The linkage between the statements arises because the

recognition of one element (or a change in one element) requires the recognition of an equal amount in

one or more other elements (or changes in one or more other elements) as per the accounting equation.

For example, income and expenses are recognised in the statement(s) of financial performance only if

an increase or decrease in the carrying amount of an asset or a liability is also recognised. Thus, the

recognition of income occurs simultaneously with the initial recognition of an asset, or an increase in the

carrying amount of an asset or the derecognition of a liability, or a decrease in the carrying amount of a

liability. Consider the sale of goods for cash. Income is recognised (revenue from the sale of goods) and

an asset is increased (cash at bank). Similarly, the recognition of expenses occurs simultaneously with

the initial recognition of a liability, or an increase in the carrying amount of a liability or the derecog-

nition of an asset, or a decrease in the carrying amount of an asset. Consider the payment of wages. An

expense is recognised (wages) and there is a decrease in the carrying amount of an asset (cash).

There are no definitive rules to assist the decision of whether an item should be recognised. The

recognition decision requires judgement. The overarching consideration when deciding to recognise an

asset or a liability (and any related income, expenses or changes in equity) is whether the recognition

provides financial statement users with relevant information about the asset or the liability and about

any income, expenses or changes in equity, a faithful representation of the asset or the liability and of

any income, expenses or changes in equity, and information that results in benefits exceeding the cost of

providing that information.

The factors to consider when making a recognition decision are as follows.

• Uncertainty: if it is uncertain whether an asset exists, or is separable from goodwill, or whether a lia-

bility exists. For example, customer relationships are not contractual and therefore uncertainty exists

as to whether these are assets or whether they are separable from the business as a whole.

• Probability: if an asset or a liability exists, but there is only a low probability that an inflow or outflow

of economic benefits will result. For example, an entity is being sued for a claimed act of wrongdoing

but the probability of having to pay damages is assessed as low.

• Measurement uncertainty: if a measurement of an asset or a liability can be obtained, but the level

of measurement uncertainty is high, impacting the relevance of the information. For example, the

economic benefits are derived from modelling diverse scenarios with numerous assumptions and esti-

mations so that the reasonableness of the estimation is questionable.

If due to uncertainty or unreliable measurement an asset or liability is not recognised, an entity always

has the option to disclose information concerning the asset or liability in the notes to the accounts sup-

porting the financial statements. The term ‘contingent’ is often used to describe such assets or liabilities.

For example, an entity may be embroiled in a court case, resulting in a contingency being disclosed in

the entity’s notes to the accounts.

Figure 5.3 provides a summary of the asset and liability definition and recognition criteria discussed

in the preceding sections.