Elements Of Financial Statements And Essential Characteristics Of Assets

Questions

The current assignment is about AASB’s accounting conceptual framework, 2014 that has been applied upon financial reports prepared on or after July 1, 2014. It is expected by the accounting industry to account for transactions in such a way that a qualitative report is being made. Company accountants are expected to address the information which are critical in nature for developing the appropriate accounting standard. The four fundamental issues are definition of the element of financial statement, recognition and measurement of such elements and appropriate disclosures related to that. The AASB has to consider the above stated issues while presenting a framework for preparation and presentation of financial statements (Atkinson, 2012).

However, controversies arises in relation to the fourth issue, that is, disclosure requirements. The AASB framework of 2014 is criticized on this ground that proper guidance aren’t provided as to what disclosures should be made and not. The principles and practices regarding disclosures are not clearly stated by AASB. 

Chapter 3 enumerates the role of financial reports. It :

• Tells us that financial statements are prepared using the perception of the organization as a whole, instead of the perception of dependent stakeholders such as lenders, investors or shareholders or other creditors.
• Follows the assumption of going concern which is brought forward from the existing conceptual framework.

Chapter 4 discusses the elements of financial statements. Elements of financial statements are described as such important elements that has to be a part of entities or upon which the entity depends. Such elements need to be presented in the most appropriate manner in the balance sheet along with required disclosures in the notes. Balance sheet or revenue statement presentation means presenting such elements (Berry, 2009). The elements of financial statements si stated and discussed in brief below:

1. Assets: An asset is considered as an economic resource which is a result of past actions and is controlled by the organization. The term economic resource is defined as the capability to produce economic benefits for the company.
2. Liability: a liability is an obligation over the company in the present which requires the transferring of economic resource and has occurred due to past events.
3. Equity: Equity is defined as the financial strength of an entity as it shows the interests of the owners in the assets of the organization after removing the liabilities in terms of values (Boyd, 2013).
4. Income: As the name suggests, it is the increase in the equity value of the owners due to either there is an increase in the assets or decrease in the liabilities and is totally different from the investments made by the equity holders.
5. Expenses: Expenses are totally an opposite of incomes. It results in the decrease of equity value if there is a decrease in assets or increase in liabilities and is totally different from distributions made to the equity holders voluntarily.

The stated elements of financial statements are required to be compared on the basis of definition and recognition. Such comparison can be explained with the help of the following table:

Elements of financial statements	Definition	Criteria for Recognition
Assets	Assets are the resources through which an entity derives economic benefits. Such assets are under the control of the entity.	An asset is required to be recognized only when : · It is probable that economic benefits would occur in the future ; · The asset has a cost or can be measured in values reliably.
Liabilities	Liabilities are an obligation on the entity that it has to pay back and would be satisfied by using the economic benefits. It is a result of past transactions of the company.	A liability is required to be recognized only when : · It is probable that such liabilities have to satisfy through a sacrifice from the economic benefits of the company. · The value of the liabilities is measurable in terms of value.
Equity	It is the net assets after deduction of liabilities which represents the interests of the company owners.	There are no such criteria as it is simply a deduction of liabilities from the assets.
Revenues/Incomes	In simple words, revenue can be defined as an inflow in the company during a reporting period. It can accrue for a number of reasons such as increase in assets, decrease in liabilities, savings in costs,etc.	Revenue is to be recognized only when : · It is probable that such inflow has occurred in actuality whether the amount has been received or not ; · Such amount can be measured reliably.
Expenses	In simple words, Expenses can be defined as an outflow in the company during a reporting period. It can accrue for a number of reasons such as increase in liabilities, decrease in assets, increase in costs, unnecessary expenditure, etc.	Expense is to be recognized only when : · It is probable that such outflow would result in the reduction of future economic benefits; · Such amount can be measured reliably.

As already discussed above regarding what an asset is, we would be here discussing the essential characteristics of an asset which can be explained as :

The definition of an asset outlines three characteristics. Firstly, there must occur economic benefits in the future (Bragg, 2016). Secondly, the entity should have a strong control over the benefits in a sense that it is able to derive such benefits by preventing others to have such benefits. Thirdly, the entity’s control over such future benefits should have occurred as a result of some happening of transactions or events. The other characteristics of an asset include tangibility, acquisition of assets at cost, legal compliances, life of an asset, etc. However, such characteristics are not essential in nature. Let us now discuss the nature of such essential characteristics:

• “Future Economic Benefits” is defined as the capacity of the entity to derive benefits from the capacity of an asset whether in physical form or not. An entity creates a value by utilizing these assets to produce such goods and services. Thus, assets serve as means for the entity to justify their objectives(Dash, 2016).
• The second essential characteristic revolves around the control of an entity which defines the ability of the entity to derive the benefits from the assets. The “control” can be defined as the right of the company to exchange the asset, or make use of it to provide the goods or services, using it as securities, or to settle some liabilities over the entity or for distribution to the entity’s owners.
• As discussed in the above point regarding the capability of the entity, such rights arises from the legal rights and can be proved through documents of possession or sanctions or such other documents that can be used as an evidence to protect the interests of the entity.
• In certain circumstances, the entity cannot deny the control to other entities to derive future economic benefits. For example, a number of entities use highways for their operations that represent future economic benefits but they cannot claim it as an asset and can be qualified as an asset for entities responsible for its operation.
• The third important characteristic include occurrence of past transactions. Assets can be either obtained through cash or credit or exchange or on installment basis. Some transactions can be of non reciprocal nature such as donations, contributions, government grants, etc. Assets may even result from discovery (Datar , 2015).

Answers

As discussed already, an asset is to be recognized only when it is probable that the future economic benefits from an asset will occur and that the cost of the asset can be reliably measured ( Datar ,2015).

For the sake of recognition in terms of value, it is important for an asset to possess a cost that can be measured reliably. The term reliable is used in reference to the term ‘reliability’ used in SAC 3 “Qualitative Characteristics Of Financial Information “The basis of measuring an asset depends upon the accounting model used by the reporting entity. In most cases the assets would already have a value or cost (Donanldson, 2012). However, in cases where the cost cannot be identified, the item couldn’t be recognized as an asset under any of the accounting models. For example, a mining company might discover the existence of minerals at one of its sites at some insignificant cost but couldn’t report for the exact value.

AASB 113 requires fair value measurement of assets. Here, fair value refers to the market value measurement. It defines a price at which a transaction might take place to sell off an asset to other market participants under the present market conditions on a measurement date. Where a price is not available in the market, the entity uses other valuation techniques.

The arguments to support the measurement of assets by fair value approach are because of the following objectives:

• Fair value measurement is considered as the most relevant approach for making decisions. Such an amount is relevant for making decisions whether to sell it off or to held it or to lease it out or for comparison purposes.
• Fair value measurement is a determination in reference to the market price which is determined by the external forces which are out of control of the entity. In this way, the price wouldn’t be regarded as biased and the same value couldn’t be manipulated or controlled by the entity (Edwards, 2014).
• Such measurement would reveal the true capacity of an entity as the fair value considers depreciation and in that way, the value of asset tends to decrease with every year showing the true value. However, entities following historical costing would not show a true measurement of assets as if an asset has a life of 10 years, suppose, it would be showing the value of first year in the 10th year. Thus, unnecessarily the asset side of a company would be more than its actual capacity or value.

Historical costing is an uniform and simple accounting model that prefers using the original cost of an asset (Girard, 2014). The reasons for using of historical costing by accountants in spite of certain disagreement can be enumerated as :

1. Adopting fair value measurement is a subjective concept ad different person’s can adopt different methods of valuation. Due to fair value measurement, people would measure their assets at a price higher than the actual cost so as to show a strong position of the company. Also, they might use the market conditions of recession, decline, trade cycles, etc so as to show a downward revaluation and charge it to profit and loss account, this saving themselves from tax norms. Recording assets at their original cost helps in eradicating the problem of window dressing.
2. FMV can lead to serious circumstances of not valuing an asset properly such as volatility in market would change the value of an asset on a daily basis; companies might use it to show favorable and desired results in their financial statements so as to enjoy the benefits of strong creditworthiness. In the end, such companies are unable to fulfill their credit pressure and end up being bankrupt (Gow, 2016).

Stewardship theory is entrusting the responsibility on the managers to take control of the assets in a say to provide sufficient interests to its shareholders. Thus, stewardship distinguishes between responsibility for actions and responsibility for managing where responsibility of managing has the responsibility of decisions or actions that might take place on the basis of that. Relating the historical approach with stewardship theory, it can be said that the accountants are considering stewardship as a goal (Holtzman, 2013).

The term ‘disclosure overload’ became an issue in financial report that became one of the topmost priorities of IASB or Board (Horngren, 2012). The reasons why there was no reference to disclosures practices in financial reporting are:

• The common format cannot be used for representing every kind of information. Therefore, due to increase in volume of information and complex accounting standards, use of different formats can be used to deliver a better understanding of the financial reports (Mattessich, 2016).
• The users of financial reports find disclosures overlapping and therefore, they do not find useful decision making information.
• There is a little knowledge of deciding a fact as material or immaterial. Thus, disclosure overload increases if the information disclosed are of immaterial nature (McLaney & Adril, 2016).

Let us consider the annual report of 2017 of BHP Billiton Ltd. In case of this company, the noncurrent assets show a value of $80,497 million.

Role of Financial Reports

This property, plant and equipment is measured at cost after eliminating accumulated depreciation and impairment charges (Rosenfield, 2009). Cost here represents the fair value of the transaction undertaken before to own the asset at the time the asset was bought and includes the costs directly associated with the asset such as installation costs, conditions necessary for bringing the asset into operation and the provisions related to future closure costs. In a similar way, leased assets which are recorded as property, plant and equipment are recorded at the lower of the fair value or the estimated value of the minimum lease payments currently. The basis of depreciating the leased assets is same as that of company’s owned assets (Schroeder, 2014).

In notes to accounts, after the actual fair value is obtained, the company just after that represents the historical cost in one row and accumulated depreciation and impairments in another row. In the following case, the cost is $157, 666 millions and accumulated depreciation and impairments is $77,169 million. Thus presenting the fair value in the balance sheet for the true and fair view condition and representing the cost and depreciation amount in the disclosures so as to provide complete information to the users of the financial reports (Scott, 2014).

Conclusion

The conclusion of the following assignment understands the changes incorporated in conceptual framework by adopting practices from IASB framework. The AASB practices of not considering disclosure requirements have to be eliminated completely. Already, the AASB is working towards providing necessary guidance to incorporate sufficient disclosure requirements that fulfills the conditions of an unqualified financial report. It would take time but it would deliver the best possible results and would improve the quality and quantity of financial reports.

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