Accounting Elements

Accounting elements

The first step in the accounting for any transaction, event or circumstance is identifying the accounting element:

This page explains and interprets how the IASB and FASB conceptual frameworks (CF and CON respectively) define terms like asset, liability or revenue.

Why is this necessary?

For example, the Oxford dictionary defines an asset "as a thing of value, especially property, that a person or company owns, and that can be used or sold to pay debts."

In contrast, the IFRS conceptual framework defines an asset as "a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits."

Similar, but different (in some important ways).

To accomplish its task, this page cites and includes quotations from the conceptual frameworks published by the IASB (CF) and FASB (CON). Where pertinent, it quotes and compares both conceptual frameworks. Otherwise, it quotes whichever framework provides the more pertinent guidance.

These quotations are intentionally kept as short as possible and/or edited, so as to constitute fair use as this term is understood under section 107 of the Copyright Act 1976.

Readers of this page are strongly advised to consult the full text of each framework.

It is free to download on the IASB web site and FASB web site.

  1. Assets
  2. Liabilities
  3. Equity
  4. Revenue
  5. Expenses
  6. Gains
  7. Losses
  8. Investments by owners
  9. Distributions to owners
  10. Comprehensive income

Assets

Put simply, assets are rights that will generate cash in the future.

As outlined in CON 4.8.E16, an asset is a present right of an entity to an economic benefit.

Similarly, in CF 4.3 & 4 an asset is a present economic resource controlled by the entity as a result of past events in that an economic resource is a right that has the potential to produce economic benefits.

Control, the exclusive ability to use an asset, is critically important. Without control, an asset cannot exist.

CF 4.20 (emphasis added): An entity controls an economic resource if it has the present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it. Control includes the present ability to prevent other parties from directing the use of the economic resource and from obtaining the economic benefits that may flow from it. It follows that, if one party controls an economic resource, no other party controls that resource.

CF 4.9 (emphasis added): .. to be assets ... the rights must both have the potential to produce for the entity economic benefits beyond the economic benefits available to all other parties ... and be controlled by the entity ... For example, rights available to all parties without significant cost [for instance, rights of access to public goods... ] are typically not assets...

Nevertheless, only the CF explicitly mentions control. The FASB explains why the CON does not.

BC4.22. The Board redeliberated the issue and decided that the term control should not be used in the definition of an asset for the following reasons:

  1. It eliminates redundancy. If an entity has a present right, that would seem to be sufficient to establish the fact that the asset is an asset of that entity ...
  2. It eliminates misunderstanding of the term ... The Board notes that what is controlled is the existing right that gives rise to economic benefits, or potential economic benefits, rather than the economic benefits themselves...
  3. It avoids confusion with the IASB’s Conceptual Framework ... The Board notes that convergence with the IASB’s asset definition on this point is not critical because it could perpetuate the misunderstanding discussed above.

The difference between a having right and controlling a resource that is a right is merely semantic.

As outlined in CF 4.6, rights either correspond or do not correspond to obligations of other parties.

Examples of the former: accounts receivable, pre-paid goods or services, call or put options.

Examples of the latter: goods in inventory, machinery, equipment, patents, copyrights.

As outlined in CF 4.7, rights may or may not be established by contract or legislation.

Examples of the former: owned or leased equipment, license agreements, shares or debentures issued by another company.

Examples of the latter: unpatented technology or other know-how not in the public domain, a right derived from the constructive (rather than legal) obligation of another entity.

While both the CON and CF refer to "economic benefits" rather than cash, from a practical perspective, economic benefits and cash are synonymous.

CON 4.8.E19 (edited, emphasis added): Essential to the definition of an asset is a right to an “economic benefit” — the capacity to provide services or benefits to the entities that use them. Generally, in a business entity, that economic benefit eventually results in potential net cash inflows to the entity...

While the CF is less explicit, three out of the five ways economic resource could produce economic benefits directly involve cash.

CF 4.16: An economic resource could produce economic benefits for an entity by entitling or enabling it to do, for example, one or more of the following:

  1. receive contractual cash flows or another economic resource;
  2. exchange economic resources with another party on favourable terms;
  3. produce cash inflows or avoid cash outflows by, for example:
    1. using the economic resource either individually or in combination with other economic resources to produce goods or provide services;
    2. using the economic resource to enhance the value of other economic resources; or
    3. leasing the economic resource to another party
  4. receive cash or other economic resources by selling the economic resource; or
  5. extinguish liabilities by transferring the economic resource.

Assets include: Cash, Investments, Receivables (contract assets), Inventory, Accruals, Property plant and equipment (PP&E), Intangibles (including right of use assets) and Goodwill.

In the G/L, assets are sub-classified (disaggregated) until the unit of account is reached.

As neither IFRS nor US GAAP specify a particular unit of account, the level of disaggregation depends on how a particular company uses its assets.

CF 4.52: Just as cost constrains other financial reporting decisions, it also constrains the selection of a unit of account. Hence, in selecting a unit of account, it is important to consider whether the benefits of the information provided to users of financial statements by selecting that unit of account are likely to justify the costs of providing and using that information. In general, the costs associated with recognizing and measuring assets, liabilities, income and expenses increase as the size of the unit of account decreases. Hence, in general, rights or obligations arising from the same source are separated only if the resulting information is more useful and the benefits outweigh the costs.

Since CON 8.4 does not provide any guidance on units of account, the same procedure would be acceptable under US GAAP.

For example, if company acquired a production line to manufacture a generation of a product, intends to use that line only for that generation and dispose of the line when a new generation is introduced, it would be logical to treat the production line as a single unit of account.

If, however, the company intends to disassemble the line and reinstall some of its component machines in different production lines later, it would be logical to treat the individual machines as units of account.

CF 4.51 (emphasis added): A unit of account is selected to provide useful information, which implies that:

  1. the information provided about the asset or liability and about any related income and expenses must be relevant. Treating a group of rights and obligations as a single unit of account may provide more relevant information than treating each right or obligation as a separate unit of account if, for example, those rights and obligations:
    1. cannot be or are unlikely to be the subject of separate transactions;
    2. cannot or are unlikely to expire in different patterns;
    3. have similar economic characteristics and risks and hence are likely to have similar implications for the prospects for future net cash inflows to the entity or net cash outflows from the entity; or
    4. are used together in the business activities conducted by an entity to produce cash flows and are measured by reference to estimates of their interdependent future cash flows ...

In the accounts, assets are sub-classified (disaggregated) until the unit of account is reached.

As neither IFRS nor US GAAP specify a particular unit of account, the level of disaggregation depends on how a particular company uses its assets.

CF 4.52: Just as cost constrains other financial reporting decisions, it also constrains the selection of a unit of account. Hence, in selecting a unit of account, it is important to consider whether the benefits of the information provided to users of financial statements by selecting that unit of account are likely to justify the costs of providing and using that information. In general, the costs associated with recognizing and measuring assets, liabilities, income and expenses increase as the size of the unit of account decreases. Hence, in general, rights or obligations arising from the same source are separated only if the resulting information is more useful and the benefits outweigh the costs.

Since CON 8.4 does not provide any guidance on units of account, the same procedure would be acceptable under US GAAP.

For example, if company acquired a production line to manufacture a generation of a product, intends to use that line only for that generation and dispose of the line when a new generation is introduced, it would be logical to treat the production line as a single unit of account.

If, however, the company intends to disassemble the line and reinstall some of its component machines in different production lines later, it would be logical to treat the individual machines as units of account.

A unit of account is selected to provide useful information, which implies that:

  1. the information provided about the asset or liability and about any related income and expenses must be relevant. Treating a group of rights and obligations as a single unit of account may provide more relevant information than treating each right or obligation as a separate unit of account if, for example, those rights and obligations:
    1. cannot be or are unlikely to be the subject of separate transactions;
    2. cannot or are unlikely to expire in different patterns;
    3. have similar economic characteristics and risks and hence are likely to have similar implications for the prospects for future net cash inflows to the entity or net cash outflows from the entity; or
    4. are used together in the business activities conducted by an entity to produce cash flows and are measured by reference to estimates of their interdependent future cash flows

Why cash is an economic benefit (and hence an asset) should be self-evident, nevertheless CON 4.8.E32 still explains: Cash (including deposits in banks) is valuable because of what it can buy. It can be exchanged for virtually any good or service that is available, or it can be saved and exchanged for goods and services in the future. The purchasing power of cash is the basis of its value and economic benefit.

Accruals (specifically accrued assets) should comprise pre-paid expenses and accrued income (revenue).

In practice however, accruals are commonly used as a catchall category for items not material enough to be presented separately.

For example, while returnable deposits are technically not pre-paid expenses, they are often aggregated with pre-paid expenses for reporting purposes.

Similarly, even though they are different from other accruals, deferred tax assets are often included in the accruals line item on the balance sheet.

However, while acceptable for reporting purposes (assuming the amounts a not material), for recognition purposes, each individual item should have its own account.

Although clearly intangible, goodwill should always be segregated other intangible assets.

The main reason, it is not clear if goodwill will, or even can, produce economic benefits.

CON 4.8.E19 (emphasis added): Essential to the definition of an asset is a right to an “economic benefit” — the capacity to provide services or benefits to the entities that use them. Generally, in a business entity, that economic benefit eventually results in potential net cash inflows to the entity. ...

Though goodwill itself cannot provide any service or benefit, it could be argued that the synergies created by combining two businesses (goodwill can only be recognized in a business combination) can.

The other issue, goodwill is not, in and of itself, a right because, as CON 4.8.E22 points out "A right entitles its holder to have or obtain something or to act in a certain manner."

Again, it could be argued that goodwill actually represents a right to the synergies created by combining two businesses, although that is beginning to look like a bit of a stretch.

The point is, to many, goodwill is not an asset as the term “asset” is understood by the CF and CON.

Be that as it may, CON 4.8.E36 states: Generalizations about facts and circumstances that bring about internally generated intangible assets are so varied that whether an asset has been created often must be resolved at the standards level. For its part, CF.SP1.2 states: The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard.

Thus, since both ASC 805-30-25-1 and IFRS 3.32 require goodwill to be recognized as an asset, goodwill shall be recognized as an asset regardless of whether it is appears to be an asset.

However, as there is nothing in the standards that dictates that goodwill must be presented on the balance sheet as a subclassification of intangible assets. Consequently, it should always be presented separately.

Liabilities

Put simply, liabilities are obligations that will require cash in the future.

CON 4.8 E37: A liability is a present obligation of an entity to transfer an economic benefit.

While both the CON and CF refer to "economic benefits" rather than cash, from a practical perspective, economic benefits and cash are synonymous.

CON 4.8.E19 (edited, emphasis added): Essential to the definition of an asset is a right to an “economic benefit” — the capacity to provide services or benefits to the entities that use them. Generally, in a business entity, that economic benefit eventually results in potential net cash inflows to the entity...

While the CF is less explicit, three out of the five ways economic resource could produce economic benefits directly involve cash.

CF 4.16: An economic resource could produce economic benefits for an entity by entitling or enabling it to do, for example, one or more of the following:

  1. receive contractual cash flows or another economic resource;
  2. exchange economic resources with another party on favourable terms;
  3. produce cash inflows or avoid cash outflows by, for example:
    1. using the economic resource either individually or in combination with other economic resources to produce goods or provide services;
    2. using the economic resource to enhance the value of other economic resources; or
    3. leasing the economic resource to another party
  4. receive cash or other economic resources by selling the economic resource; or
  5. extinguish liabilities by transferring the economic resource.

CF 4.2: A present obligation of the entity to transfer an economic resource as a result of past events.

The obligation can be to a person(s), a company(ies), a government(s) or society at large.

CON 4.8 E37. Liabilities necessarily involve other parties, society, or law. The identity of the other party or recipient need not be known to the obligated entity before the time of settlement.

Taxes are a good example of a liability to a government while a provision made to clean up damage to the environment is a example of an obligation to society.

The obligation can be legal or constructive.

Some obligations exist because they are legally enforceable (outlined in contracts, required by legislation, mandated by regulations, etc.). Other obligations exist simply because they are the right thing to do. The latter are generally referred to as constructive obligations.

While both the CF and CON discuss constructive obligations, they are not identical.

A key difference, unlike CON 4.8 E50, CF 4.31 includes a no practical ability to avoid condition.

CON 4.8 E50 states: Some liabilities rest on constructive obligations, including some that arise in exchange transactions. A constructive obligation is created, inferred, or construed from the facts in a particular situation rather than contracted by agreement with another entity or imposed by government. An entity may become constructively obligated through customary business practice. In the normal course of business, an entity conducting certain activities may not create a clear contractual obligation but may nonetheless cause the entity to become presently obligated. For example, policies and practices for sales returns and those for warranties in the absence of a contract may create a present obligation because the pattern of behavior may create an enforceable claim for performance that would be upheld in the ultimate conclusion of a judiciary process.

CF 4.31 states (emphasis added): Many obligations are established by contract, legislation or similar means and are legally enforceable by the party (or parties) to whom they are owed. Obligations can also arise, however, from an entity’s customary practices, published policies or specific statements if the entity has no practical ability to act in a manner inconsistent with those practices, policies or statements. The obligation that arises in such situations is sometimes referred to as a ‘constructive obligation’.

This implies, a contingent liability may be recognizable under US GAAP in situations where a provision would not be under IFRS, a difference reflected in the standard level.

For example, if a company sells a product that damages its customers, before it can recognize a provision under IAS 37.20, it must be sure that the customers know they are entitled to compensation. ASC 450-20-25 simply requires that the compensation be probable and estimable. Similarly if a company causes environmental damage in a country where it is not illegal to cause damage, it is likely it would need to issue a press release informing, at minimum, the citizens of that country of its intent to clean up before recognising a provision.

IAS 37.20 (emphasis added): An obligation always involves another party to whom the obligation is owed. It is not necessary, however, to know the identity of the party to whom the obligation is owed—indeed the obligation may be to the public at large. Because an obligation always involves a commitment to another party, it follows that a management or board decision does not give rise to a constructive obligation at the end of the reporting period unless the decision has been communicated before the end of the reporting period to those affected by it in a sufficiently specific manner to raise a valid expectation in them that the entity will discharge its responsibilities.

ASC 450-20-25-2 only includes two conditions: a. it is probable that an asset had been impaired or a liability had been incurred and b. the amount of loss can be reasonably estimated.

ASC 450-20-25 does not discuss the counterparty's expectations, not does ASC 450-20-55.

However, due to the convergence of some standards, there is some seepage. For example, if a company offers volume rebate it should consider if the customer expects to receive the discount before recognizing the liability under both IFRS and US GAAP.

IFRS 15.52 | ASC 606-10-32-7 (emphasis added): The variability relating to the consideration promised by a customer may be explicitly stated in the contract. In addition to the terms of the contract, the promised consideration is variable if either of the following circumstances exists:

  1. the customer has a valid expectation arising from an entity’s customary business practices, published policies or specific statements that the entity will accept an amount of consideration that is less than the price stated in the contract. That is, it is expected that the entity will offer a price concession. Depending on the jurisdiction, industry or customer this offer may be referred to as a discount, rebate, refund or credit.
  2. other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer.

Most often, obligations are settled (liabilities extinguished) in cash. For example, a company repays a loan by transferring cash into the lender's bank account.

ASC 405-20-40-1: ... a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met:

a. The debtor pays the creditor and is relieved of its obligation for the liability. Paying the creditor includes the following:

1. Delivery of cash

2. Delivery of other financial assets

3. Delivery of goods or services

4. Reacquisition by the debtor of its outstanding debt securities whether the securities are cancelled or held as so-called treasury bonds. ...

IFRS 9.B3.3.1: A financial liability (or part of it) is extinguished when the debtor either:

(a) discharges the liability (or part of it) by paying the creditor, normally with cash, other financial assets, goods or services; or ...

A liability can also be extinguished by transferring an asset other than cash. For example, if a company receives a deposit from a customer, it can settle the obligation by delivering the product or merchandise.

A liability can also be extinguished indirectly. For example, if a company receives a pre-payment for its services, it can settle the obligation by paying wages to the employees who perform the service.

Finally, a liability can also be extinguished through forgiveness or process of law, although this is less common.

ASC 405-20-40-1: ... a debtor shall derecognize a liability if and only if it has been extinguished. A liability has been extinguished if either of the following conditions is met: ...

b. The debtor is legally released from being the primary obligor under the liability, either judicially or by the creditor. For purposes of applying this Subtopic, a sale and related assumption effectively accomplish a legal release if nonrecourse debt (such as certain mortgage loans) is assumed by a third party in conjunction with the sale of an asset that serves as sole collateral for that debt.

IFRS 9.B3.3.1: A financial liability (or part of it) is extinguished when the debtor either: ...

(b) is legally released from primary responsibility for the liability (or part of it) either by process of law or by the creditor. (If the debtor has given a guarantee this condition may still be met.)

Liabilities include: Accounts payables, Notes payable, Accruals, Loans, Bonds (debentures), Lease liabilities and Provisions (contingent liabilities).

In British usage, a debenture is a bond secured by a company's assets.

In American usage, a debenture is an unsecured bond (Investopedia).

IAS 37.27 states: An entity shall not recognise a contingent liability.

ASC 450-20-25-2 states: An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: ...

On the surface, it appears IFRS and US GAAP provide opposite guidance.

However while IAS 37.9 defines (emphasis added) "A contingent liability is: (a) a possible obligation that arises from past events and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity ...", ASC 450-20-20 defines a contingency as "An existing condition, situation, or set of circumstances involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) to an entity that will ultimately be resolved when one or more future events occur or fail to occur."

The second part of the definition: "(b) a present obligation that arises from past events but is not recognised because:
(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) the amount of the obligation cannot be measured with sufficient reliability" does not lead to a similar misunderstanding.

Thus, as explained in CON 8.4.E60 the difference between a provision (IAS 37) and contingent liability (ASC 450) is merely semantic.

E60 (emphasis added): Sometimes present obligations with uncertain amounts and timing are referred to as contingent liabilities. The term contingent liability has been a source of confusion because it is often thought to refer to circumstances in which the existence of an obligation depends on the occurrence or nonoccurrence of a future event. Absent a present obligation, the occurrence or nonoccurrence of a future event does not by itself give rise to a liability. Some items commonly described as contingent liabilities satisfy the definition of a liability because the contingency does not relate to whether a present obligation exists but instead relates to one or more uncertain future events that affect the amount that will be required to settle the present obligation. For those obligations, the fact that the outcome is unknown affects the measurement but not the existence of the liability.

Equity (net assets)

Put simply, equity is the difference between assets and liabilities.

CON 4.8 E61. The terms equity or net assets represent the residual interest in the assets of an entity that remains after deducting its liabilities.

CON 4.8 Footnote 12. This chapter generally applies the term equity to business entities, which is common usage, and the term net assets to not-for-profit entities, for which the term equity is less commonly used. The two terms are interchangeable.

Equity is only recognized and never measured. Its value is simply calculated by subtracting liabilities from assets.

This makes the accounting for equity relatively simple, merely involving proper sub-classification.

Equity is generally sub-classified: paid-in capital, retained earnings, accumulated OCI and other items.

Paid-in capital can include Issued capital (the nominal value of shares, common or preferred, or other equity interests), Additional paid-in capital (amounts paid in excess of nominal value).

Retained earnings are generally sub-classified as unappropriated (available for dividends) and appropriated (not available for dividends).

In jurisdictions where shareholders (rather the board of directors) declare dividends current period income (a.k.a. income in approval process) would be accounted for separately from prior years' retained income.

At cumulatively unprofitable companies, instead of retained earnings a retained loss (retained earnings deficit) is presented.

While US GAAP uses the term Accumulated Other Comprehensive Income, IFRS prefers the term Reserves. The AccumulatedOtherComprehensiveIncome item in IFRS XBRL thus comprises reserves.

ReserveOfExchangeDifferencesOnTranslation
ReserveOfCashFlowHedges
ReserveOfGainsAndLossesOnHedgingInstrumentsThatHedgeInvestmentsInEquityInstruments
ReserveOfChangeInValueOfTimeValueOfOptions
ReserveOfChangeInValueOfForwardElementsOfForwardContracts
ReserveOfChangeInValueOfForeignCurrencyBasisSpreads
ReserveOfGainsAndLossesOnFinancialAssetsMeasuredAtFairValueThroughOtherComprehensiveIncome
ReserveOfInsuranceFinanceIncomeExpensesFromInsuranceContractsIssuedExcludedFromProfitOrLossThatWillBeReclassifiedToProfitOrLoss
ReserveOfInsuranceFinanceIncomeExpensesFromInsuranceContractsIssuedExcludedFromProfitOrLossThatWillNotBeReclassifiedToProfitOrLoss
ReserveOfFinanceIncomeExpensesFromReinsuranceContractsHeldExcludedFromProfitOrLoss
ReserveOfGainsAndLossesOnRemeasuringAvailableforsaleFinancialAssets
ReserveOfRemeasurementsOfDefinedBenefitPlans
ReserveOfGainsAndLossesFromInvestmentsInEquityInstruments
ReserveOfChangeInFairValueOfFinancialLiabilityAttributableToChangeInCreditRiskOfLiability

Other items can include Treasury stock (own shares), Subscriptions Receivable, Unearned ESOP Shares, Warrants and Rights Outstanding, etc.

When the amounts are not material, non-controlling interests are also often included in other equity.

Revenue

Put simply, revenue (income) is cash generated by the sale of goods or services.

CON 4.8.E80 states: Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities.

The CON 8.4 does not specify what "an enhancement" is (nor did CON 6, which also used the term).

Consequently "an enhancement" should be interpreted to mean a change in the value of an asset that is not caused by a nonreciprocal transaction or event, an exchange transaction, or a holding gain, as all three of these would be classified as gains rather than revenue.

For its part, the CF does not mention enhancements at all, focusing on instead changes in assets a liabilities.

CF 4.68 states: Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.

Most of the time, the initial inflow (increase) is a receivable or contract asset. Both, however, eventually become cash.

Similarly, a loan or lease agreement also eventually leads to cash.

Even a barter sale will eventually lead to cash. For example, if a company exchanges its product for tanker of diesel and then sells the diesel, it receives cash. If uses the diesel is saves the cash it would have had to spend to buy the diesel. If it exchanges if for a tractor, it saves the cash it would have had to spend to buy that tractor.

A liability would be settled (decreased), for example, if the company had received a cash advance before it delivered its product to a customer.

In contrast to US GAAP, IFRS considers income rather than revenue to be an accounting element.

Compared to the previous CF, the revised CF also pared the guidance to the bare minimum.

4.29 The definition of income encompasses both revenue and gains. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, interest, dividends, royalties and rent.

4.30 Gains 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 element in this Conceptual Framework.

4.31 Gains include, for example, those arising on the disposal of non-current assets. The definition of income also includes unrealised gains; for example, those arising on the revaluation of marketable securities and those resulting from increases in the carrying amount of long-term assets. When gains are recognised in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions. Gains are often reported net of related expenses. ...

4.68: Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims.

Among the changes, the discussion of the difference between revenue and gains has been eliminated. Nevertheless, the distinction between revenue and gains continues to be drawn on both the standard and reporting levels.

IAS 1.9 states (edited, emphasis added): Financial statements are a structured representation of the financial position and financial performance of an entity. ... To meet this objective, financial statements provide information about an entity’s: ... (d) income and expenses, including gains and losses; ...

IAS 16.68 (edited, emphasis added): The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss ... Gains shall not be classified as revenue.

IFRS XBRL includes items like ForeignExchangeGain or GainsOnDisposalsOfInvestmentProperties.

Revenue is often broken down into (regular) Revenue and Other revenue.

(Regular) Revenue results from regular activities (the sale or goods and services in the ordinary course of business) while Other revenue from other activities (such as lending, renting or licensing).

CON 4.8.E84 (emphasis added). Revenues and expenses result from delivering or producing goods, rendering services, or carrying out other activities. Other activities ... are those activities that permit others to use the entity’s resources, which, for example, result in interest, rent, royalties, and fees...

Obviously, the distinction between regular and other depends on the nature of the business. For example, while lending would generally be an other activity at a manufacturer of industrial machines, it would be a regular activity at a bank.

Revenue is recognized either at a point of time (most goods) or over time (most services).

Expenses

Put simply, expenses are cash consumed to facilitate the sale of goods or services.

CON 4.8.E81 states: Expenses are outflows or other using up of assets of an entity or incurrences of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities.

CF 4.69: Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.

Nevertheless, the result is inevitably a cash outflow.

For example, to manufacture a product a company must buy material and pay wages. In the past, it also had to expend cash to buy machinery or licenses.

Likewise, selling a product often requires the company to pay a commission.

Finally, simply running a business requires, besides salaries, expenditure on items ranging from office rents and consulting fees to marketing and R&D.

However, as with most generalizations, there is a glaring exception.

Stock (share) based payments do not involve cash nor do they seem to be an outflow or other using up (decrease) of assets, or incurrence (increase) in liabilities at all.

Thus, to many, shares, stock purchase warrants, employee stock options are equity instruments and so do not fulfill the definition of expense.

CON 4.8.E81: Expenses are outflows or other using up of assets of an entity or incurrences of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities.

CF 4.69: Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.

While the FASB did address these concerns when it originally published FAS 123, many are still unconvinced.

Expenses and Capital Transactions

Note, in IFRS 2, the IASB reached the same conclusion for the comparable reasons.

IFRS 2.BC53:The FASB considered the same issue and reached the same conclusion in SFAS 123:

Some respondents pointed out that the definition of expenses in FASB Concepts Statement No. 6, Elements of Financial Statements, says that expenses result from outflows or using up of assets or incurring of liabilities (or both). ...

88. Some respondents pointed out that the definition of expenses in FASB Concepts Statement No. 6, Elements of Financial Statements, says that expenses result from outflows or using up of assets or incurring of liabilities (or both). They asserted that because the issuance of stock options does not result in the incurrence of a liability, no expense should be recognized. The Board agrees that employee stock options are not a liability—like stock purchase warrants, employee stock options are equity instruments of the issuer. However, equity instruments, including employee stock options, are valuable financial instruments and thus are issued for valuable consideration, which often is cash or other financial instruments but for employee stock options is employee services. Using in the entity's operations the benefits embodied in the asset received results in an expense, regardless of whether the consideration is cash or other financial instruments, goods, or services. Moreover, even if shares of stock or other equity instruments are donated to a charity, the fair value of the instruments issued is recognized together with other charitable contributions in determining the issuer's net income. The Board recently reaffirmed that general principle in FASB Statement No. 116, Accounting for Contributions Received and Contributions Made.

89. Others noted that the issuance of an employee stock option is a capital transaction. They contended that capital transactions do not give rise to expenses. As discussed in paragraph 88, however, issuances of equity instruments result in the receipt of cash, other financial instruments, goods, or services, which give rise to expenses as they are used in an entity's operations. Accounting for the consideration received for issuing equity instruments has long been fundamental to the accounting for all free-standing equity instruments except one—fixed stock options subject to the requirements of Opinion 25.

90. Some respondents also asserted that the issuance of an employee stock option is a transaction directly between the recipient and the preexisting stockholders in which the stockholders agree to share future equity appreciation with employees. The Board disagrees. Employees provide services to the entity—not directly to the individual stockholders—as consideration for their options. Carried to its logical conclusion, that view would imply that the issuance of virtually any equity instrument, at least those issued for goods or services rather than cash or other financial instruments, should not affect the issuer's financial statements. For example, no asset or related cost would be reported if shares of stock were issued to acquire legal or consulting services, tangible assets, or an entire business in a business combination. Moreover, in practice today, even if a stockholder directly pays part of an employee's cash compensation (or other corporate expenses), the transaction and the related costs are reflected in the entity's financial statements, together with the stockholder's contribution to paid-in capital. To omit such costs would give a misleading picture of the entity's financial performance.

91. The Board sees no conceptual basis that justifies different accounting for the issuance of employee stock options than for all other transactions involving either equity instruments or employee services. As explained in paragraphs 57-62, the Board's decision not to require recognition of compensation expense based on the fair value of options issued to employees was not based on conceptual considerations.

However, ASC 105-10-05-3 states: Accounting and financial reporting practices not included in the Codification are nonauthoritative. Sources of nonauthoritative accounting guidance and literature include, for example, the following: ... b. FASB Concepts Statements ... while CF.SP1.2 states: The Conceptual Framework is not a Standard. Nothing in the Conceptual Framework overrides any Standard or any requirement in a Standard.

This implies, since both ASC 718 and IFRS 2 require share-based compensation to be recognized as an expense, share based compensation is recognized an expense regardless of whether it is appears to fulfill the definition of expense.

In contrast to US GAAP, IFRS considers expenses and losses to be a single accounting element.

Compared to the previous CF, the revised CF has been pared down to the bare minimum.

4.33 The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. Expenses that arise in the course of the ordinary activities of the entity include, for example, cost of sales, wages and depreciation. They usually take the form of an outflow or depletion of assets such as cash and cash equivalents, inventory, property, plant and equipment.

4.34 Losses represent other items that meet the definition of expenses and may, or may not, arise in the course of the ordinary activities of the entity. 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 Conceptual Framework.

54.35 Losses include, for example, those resulting from disasters such as fire and flood, as well as those arising on the disposal of non-current assets. The definition of expenses also includes unrealised 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. When losses are recognised in the income statement, they are usually displayed separately because knowledge of them is useful for the purpose of making economic decisions. Losses are often reported net of related income.

CF 4.69: Expenses are decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims.

Nevertheless, the distinction between expenses and losses continues to be drawn on both the standard and reporting levels.

IAS 1.9 states (edited, emphasis added): Financial statements are a structured representation of the financial position and financial performance of an entity. ... To meet this objective, financial statements provide information about an entity’s: ... (d) income and expenses, including gains and losses; ...

IAS 16.68 (edited, emphasis added): The gain or loss arising from the derecognition of an item of property, plant and equipment shall be included in profit or loss ...

IFRS XBRL thus includes items like ForeignExchangeLoss or LossesOnDisposalsOfInvestmentProperties.

Some expenses (cost of sales, selling and distribution) correlate with the sale of goods and services and also occur at, or close to, the same time.

Some are direct (direct material, production wages, billable hours, sales commissions, shipping, etc.) others indirect (production supplies, utilities, supervisor salaries, quality control, warehousing, rent, depreciation, etc.) but without them, no sales would occur.

Other expenses (administrative, general) do not correlate with sales, or only indirectly.

For example, research and development may or may not eventually lead to a sellable product and, even when it does, can precede the sales of the that product by years. Marketing and advertising do correlate somewhat, but not nearly as closely as sales commissions. Administrative salaries, like those paid to accounting staff, are paid, at more or less the same levels, regardless of the level of sales.

Nevertheless, without development, advertising and a staff to handle administration, no sales would occur.

Expenses comprise: cost of sales, selling (distribution) expenses, and general and administrative expenses.

Unlike US GAAP, which only recognizes expense by function, IFRS also recognizes expenses by nature: Raw materials and consumables used, Employee benefits expense and, Depreciation and amortisation expense.

Note: while a Changes in inventories of finished goods and work in progress account can have and Raw materials and consumables used account has a credit balance, neither should be reported as revenue, but as a contra expense.

Also note: while nature of expense only profit and loss statements are an option, the overwhelming majority of companies applying IFRS opt to present function of expense P&Ls.

Gains

Put simply, gains result when the value of an asset increases or liability decreases.

Gains usually result when the value of an asset increases (liability decreases) while its being held by a company. Gains may also result from transactions outside a company's regular earnings process.

CON 4.8.E82: Gains are increases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from revenues or investments by owners.

The earnings process generally involves delivering goods or rendering services. This leads to revenue not gains.

CON 4.8.E84: Revenues and expenses result from delivering or producing goods, rendering services, or carrying out other activities. Other activities, as referenced in the definitions of revenues and expenses in this chapter, are those activities that permit others to use the entity’s resources, which, for example, result in interest, rent, royalties, and fees. Other activities also include charitable contributions received and made.

By definition three, in practice four, circumstances lead to gains: nonreciprocal events, nonreciprocal transactions, exchange transactions and holding gains.

CON 4.8.E85: Gains and losses typically result from one of the following three circumstances:

  1. Nonreciprocal transactions or events such as natural catastrophes
  2. Exchange transactions
  3. Holding gains and losses ...

Although CON 4.8.E85 groups nonreciprocal transactions with nonreciprocal events, in practice both the accounting and reporting of these items can differ. Contently, from a practical perspective, they should be considered at two, separate items.

The first defining feature of nonreciprocal events is they are nonreciprocal: the reporting entity does not expend anything of measurable economic value in return.

The second defining feature of nonreciprocal events is they are events: they are beyond the control of the reporting entity.

While nonreciprocal loss events such as natural catastrophes are fairly common, nonreciprocal gain events are rarer.

An example of a nonreciprocal gain event would be a if a company acquired land with the intent of constructing a manufacturing facility, but discovered previously undiscovered mineral deposits during excavation.

The first defining feature of nonreciprocal transactions is they are nonreciprocal: the reporting entity does not expend anything of measurable economic value in return.

The second defining feature of nonreciprocal transactions is they are transactions: they, unlike events, are not beyond the control of the reporting entity.

Unlike nonreciprocal events, which are practically always classified as gains, nonreciprocal transactions can be classified as either gains or revenue depending on the circumstances.

For example, a charitable contribution received by a not-for-profit entity would be recognized as revenue even though the transaction is nonreciprocal.

In contrast, a government grant received by a for-profit entity would be recognized as a gain because the transaction is nonreciprocal.

As a result, the accounting for nonreciprocal gain transactions is generally outlined at the standard level.

Exchange transactions are incidental to an entity's operations.

CON 4.8.E86:... Distinctions between revenues and gains and expenses and losses from exchange transactions of an entity depend to a significant extent on the nature of the entity and the activity with which an item is associated. An identical item can be used by entities differently. As a result, the proceeds from the sale of an asset may be revenue for one entity and may be a factor in determining gain or loss for another. For example, the proceeds from the sale of a machine displayed as inventory would be considered revenue, and the cost of that machine would be considered an expense. However, the proceeds from the sale of a machine used by an entity in a productive capacity would not be considered revenue, and the entity would report a gain or a loss upon disposition of that machine to be consistent with the representations in the statement of financial position.

For example, if an entity sells a machine it manufactured for sale, it recognizes the consideration received as revenue and asset surrendered (the machine in inventory) as an expense (cost of sales).

If, on the other hand, an entity sells a machine it had previously used in production, it recognizes a gain if it receives more for the machine than its depreciated value.

Holding gains result from changes in value of the assets (increases) or liabilities (decreases) held by an entity.

For example, in year one, an industrial company buys shares of another company on the market for 1000. At the end of year one, the market value of the shares is 1200 and the company sells the shares for 1400 at the end of year two. At the end of year one it recognizes holding gain of 200 and, at the end of year two, another holding gain of 200.

It is important to note that IFRS and US GAAP look at unrealized gains differently than, for example, most tax laws. Thus, for taxation purposes, the year one gain of 200 may be considered unrealized and non-taxable. Instead, the entire 400 gain would be taxed in year two.

However, the distinction between revenue and gains is not always clear cut. Consequently, before a company elects a particular accounting policy, it must invariably consult the specific guidance provided at the standard level.

CON 4.8.E89: Gains and losses can be so basic and fundamental to an entity’s routine activities that distinguishing those gains and losses from revenues and expenses may not be as informative as presenting them with revenues and expenses. ...

CON 4.8.E90: ... Ultimately, those decisions will be made at a standards level with considerations for the objective of financial reporting and presentation concepts.

Losses

Put simply, losses result when the value of an asset decreases or liability increases.

Losses usually result when the value of an asset decreases (liability increases) while its being held by a company. Losses may also result from transactions outside a company's regular earnings process.

CON 4.8.E82: E83. Losses are decreases in equity (net assets) from transactions and other events and circumstances affecting an entity except those that result from expenses or distributions to owners.

The earnings process generally involves delivering goods or rendering services. This leads to expenses not losses.

CON 4.8.E84: Revenues and expenses result from delivering or producing goods, rendering services, or carrying out other activities. Other activities, as referenced in the definitions of revenues and expenses in this chapter, are those activities that permit others to use the entity’s resources, which, for example, result in interest, rent, royalties, and fees. Other activities also include charitable contributions received and made.

By definition three, in practice four, circumstances lead to losses: nonreciprocal events, nonreciprocal transactions, exchange transactions and holding losses.

CON 4.8.E85: Gains and losses typically result from one of the following three circumstances:

  1. Nonreciprocal transactions or events such as natural catastrophes
  2. Exchange transactions
  3. Holding gains and losses ...

Although CON 4.8.E85 groups nonreciprocal transactions with nonreciprocal events, in practice both the accounting and reporting of these items can differ. Contently, from a practical perspective, they should be considered at two, separate items.

The first defining feature of nonreciprocal events is they are nonreciprocal: the reporting entity does not receive anything of measurable economic value in return.

The second defining feature of nonreciprocal events is they are events: they are beyond the control of the reporting entity.

Nonreciprocal events are fairly common. They include natural catastrophes, impairments, accidents, theft or events that require the recognition of provisions (contingent liabilities) such as accidental damage to the environment.

The first defining feature of nonreciprocal transactions is they are nonreciprocal: the reporting entity does not receive anything of measurable economic value in return.

The second defining feature of nonreciprocal transactions is they are transactions: they, unlike events, are not beyond the control of the reporting entity.

Unlike nonreciprocal events, which are practically always classified as losses, nonreciprocal transactions are usually expenses.

For example, a charitable contribution made to a not-for profit entity would be recognized an expense even though the transaction is nonreciprocal.

Similarly, taxes paid to a government, also nonreciprocal, are classified as expenses.

Consequently, companies should classify nonreciprocal transactions as expenses unless guidance at the standard level indicates they should be classified as losses.

Exchange transactions are incidental to an entity's operations.

CON 4.8.E86:... Distinctions between revenues and gains and expenses and losses from exchange transactions of an entity depend to a significant extent on the nature of the entity and the activity with which an item is associated. An identical item can be used by entities differently. As a result, the proceeds from the sale of an asset may be revenue for one entity and may be a factor in determining gain or loss for another. For example, the proceeds from the sale of a machine displayed as inventory would be considered revenue, and the cost of that machine would be considered an expense. However, the proceeds from the sale of a machine used by an entity in a productive capacity would not be considered revenue, and the entity would report a gain or a loss upon disposition of that machine to be consistent with the representations in the statement of financial position.

For example, if an entity sells a machine it manufactured for sale, it recognizes the asset surrendered (the machine in inventory) as an expense (cost of sales) and the consideration received as revenue.

If, on the other hand, an entity sells a machine it had previously used in production, it recognizes a loss if it receives less for the machine than its depreciated value.

Holding losses result from changes in value of the assets (decreases) or liabilities (increases) held by an entity.

For example, in year one, an industrial company buys shares of another company on the market for 1000. At the end of year one, the market value of the shares is 800 and the company sells the shares for 600 at the end of year two. At the end of year one it recognizes holding loss of 200 and, at the end of year two, another holding loss of 200.

It is important to note that IFRS and US GAAP look at unrealized losses differently than, for example, most tax laws. Thus, for taxation purposes, the year one loss of 200 may be considered unrealized and not taxable deductible. Instead, the entire 400 gain would be deducted in year two.

However, the distinction between expenses and losses is not always clear cut. Consequently, before a company elects a particular accounting policy, it must invariably consult the specific guidance provided at the standard level.

CON 4.8.E89: Gains and losses can be so basic and fundamental to an entity’s routine activities that distinguishing those gains and losses from revenues and expenses may not be as informative as presenting them with revenues and expenses. ...

CON 4.8.E90: ... Ultimately, those decisions will be made at a standards level with considerations for the objective of financial reporting and presentation concepts.

Investments by owners

More or less, self-explanatory.

Nevertheless, CON 4.8.E71 does explain: Investments by owners are increases in equity of an entity resulting from transfers to the entity from other entities of something valuable to obtain or increase ownership interests (or equity) in the entity. Assets are the most common form of investments by owners, but owners’ investments also may take the form of providing services or satisfying or converting liabilities of the entity.

Distributions to owners

More or less, self-explanatory.

Nevertheless, CON 4.8.E72 does explain: Distributions to owners are decreases in equity of an entity resulting from transferring assets, rendering services, or incurring liabilities by the entity to owners. Distributions to owners decrease ownership interest (or equity) in an entity.

Comprehensive income

The sum of revenue, expenses, and all gains and losses (realized and unrealized).

Comprehensive income sums Net income (which comprises revenue, expenses and "realized" gains and losses) and Other comprehensive income (which comprises the remaining "unrealized" gains and losses).

It should be noted that IFRS and US GAAP approach the terms realized and unrealized differently than the way most people do.

To most people, realized means converted to cash, while unrealized means the opposite.

For example, if an individual purchases shares for 100 and their market value increases to 120, the individual considers this 20 gain unrealized as long as he or she does not sell the shares.

Most tax laws approach (most) realized and unrealized in the same way.

However, from and IFRS or US GAAP perspective, whether a gain or loss is treated as realized (included in net income) or unrealized (reported as other comprehensive income) depends on how fair value guidance applies to it.

As a general rule, if fair value is determined on an active market (using level one inputs), any change is treated is if it were realized (net income) regardless of where the item is sold (converted to cash) or not.

In contrast, if the value of the item is derived by applying some additional, specific accounting guidance, for example the guidance that dictates how a subsidiary with a foreign currency as its functional currency is consolidated, the change could be treated as unrealized (compressive income).

Obviously, as with any rule of thumb, the specific guidance must also be consulted (especially since the guidance sometimes appears logical, other times less so).

XYX, Inc.

Statement of Comprehensive Income

For the year ended 2XX1

In millions of currency units

Revenue

1,000

Cost of sales

500

Gross profit

500

Selling, general and administrative expenses

300

Operating income

200

Other revenue and expenses

(50)

Gains and losses

(25)

Net income

125

Other comprehensive income

(25)

Comprehensive income

100

 

 


The items to be included in comprehensive income are outlined in IAS 1 and ASC 220.

IAS 1.7 (definitions) lists items included other comprehensive income. They include financial instruments designated as fair value through other comprehensive income (FVtOCI), foreign exchange differences related to consolidation, cash flow hedges and pension liability adjustments.

As IFRS allows PP&E and intangible assets to be revalued, it also includes a revaluation surplus (unlike US GAAP, which does not allow these revaluations).

This list is updated periodically, and should be consulted each period.

ASC: 220-10-45-10A lists items of other comprehensive income. They include holding gains and losses associated with available-for-sale (AFS) debt instruments, foreign currency translation adjustments related to consolidation, cash flow hedges and pension liability adjustments.

As US GAAP does not allow PP&E and intangible assets to be revalued, it does not includes a revaluation surplus (unlike IFRS, which does allow these revaluations).

This list is updated periodically, and should be consulted each period.

The IFRS and US GAAP XBRL taxonomies summarize the items.

The taxonomies are updated periodically and should be consulted each period.

The IFRS taxonomy is available at on bigfoot, the US GAAP taxonomy on TORCS.

The IFRS taxonomy includes:

ReserveOfExchangeDifferencesOnTranslation

ReserveOfCashFlowHedges

ReserveOfGainsAndLossesOnRemeasuringAvailableforsaleFinancialAssets

ReserveOfRemeasurementsOfDefinedBenefitPlans

RevaluationSurplus

ReserveOfGainsAndLossesOnHedgingInstrumentsThatHedgeInvestmentsInEquityInstruments

The FASB taxonomy includes:

AccumulatedOtherComprehensiveIncomeLossNetOfTax

AccumulatedOtherComprehensiveIncomeLossForeignCurrencyTranslationAdjustmentNetOfTax

AociLossCashFlowHedgeCumulativeGainLossAfterTax

AccumulatedOtherComprehensiveIncomeLossAvailableForSaleSecuritiesAdjustmentNetOfTax

AccumulatedOtherComprehensiveIncomeLossOtherThanTemporaryImpairmentNotCreditLossNetOfTaxDebtSecurities

AccumulatedOtherComprehensiveIncomeLossOtherThanTemporaryImpairmentNotCreditLossNetOfTaxAvailableforsaleDebtSecurities

Unlike the CON, the CF does not consider comprehensive income a separate accounting element, so does not define it.

CON 4.8.E75: Comprehensive income is the change in equity of a business entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Nevertheless, both IFRS and US GAAP approach comprehensive income in the same way. The major difference, since US GAAP does not allow companies to remeasure (revalue) PP&E and intangible assets, a revaluation surplus is not included in US GAAP OCI.

Example: 1/1/X1 XYZ acquired an investment, which it classified at fair value through comprehensive income, for 10,000 on the market. 12/31/X1, the market value of the investment was 1,200 XYZ sold the investment for 1,500 on 12/31/X2 (for simplicity, tax is not presented in this example).

XYZ, Inc.

Statement of Comprehensive Income

For the year ended X.X.X1

Revenue

100,000

120,000

Expenses

60,000
75,000

Gain on sale of Investment (NI)

 

5,000

Net income

40,000

50,000

Other Comprehensive Income

Unrealized Gain on Investment (OCI)

2,000

3,000

Reclassification adjustment

 

(5,000)

Comprehensive income

42,000

48,000

 


CF7.19: In principle, income and expenses included in other comprehensive income in one period are reclassified from other comprehensive income into the statement of profit or loss in a future period when doing so results in the statement of profit or loss providing more relevant information, or providing a more faithful representation of the entity's financial performance for that future period. However, if, for example, there is no clear basis for identifying the period in which reclassification would have that result, or the amount that should be reclassified, the Board may, in developing Standards, decide that income and expenses included in other comprehensive income are not to be subsequently reclassified.

To recognize the investment

12/31/X1 | 31.12.X1

Investment

10,000

 

Cash

10,000


To recognize the gain to OCI

12/31/X1 | 31.12.X1

Investment

2,000

 

Gain on investment (OCI)

2,000


To close the OCI gain to accumulated OCI

12/31/X1 | 31.12.X1

Gain on investment (OCI)

2,000

 

Accumulated OCI

2,000


To recognize the gain to OCI

12/31/X2 | 31.12.X2

Investment

3,000

 

Gain on investment (OCI)

3,000


To close the OCI gain to accumulated OCI

12/31/X2 | 31.12.X2

Gain on investment (OCI)

3,000

 

Accumulated OCI

3,000


To recognize the OCI gain in NI

12/31/X2 | 31.12.X2

Cash 15,000  

Reclassification adjustment

5,000

  Investment   15,000

 

Gain on investment (NI)

5,000


To recognize the gain in NI, close accumulated OCI and close the gain to retained earnings

12/31/X2 | 31.12.X2

Gain in OCI

3,000

 

Accumulated OCI

3,000

Gain (NI)

5,000

 

Suspense account

5,000

Accumulated OCI

5,000

 

Reclassification adjustment

5,000

Suspense account

5,000

 

Retained earnings

5,000


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