Financial reporting

Topics: Balance sheet, Asset, Generally Accepted Accounting Principles Pages: 7 (2408 words) Published: October 30, 2013
Example 2.1 Recognition of an asset
Entity X enters into a legal arrangement to act as trustee for entity Y by holding listed shares on entity Y’s behalf. Entity Y makes all investment decisions and entity X will act according to entity Y’s instructions. Entity X will earn a trustee fee for holding the shares. Any dividends or profit/(loss) from the investments belong to entity Y. Elements of financial statementsThe elements of financial statements53 Entity X should not recognise the listed shares as its asset even though it is in posses- sion of the shares. Entity X does not control the investment’s future economic benefits. Benefits from the investments flow to entity Y and entity X earns a trustee fee for holding the shares regardless of how the shares perform. The listed shares, therefore, do not meet the criteria of an asset in entity X’s balance sheet. In assessing whether an item meets the definition of an asset (or a liability or equity), attention needs to be given to its underlying substance and economic reality and not merely its legal form. Thus, for example, in the case of finance leases, the substance and economic reality are that the lessee acquires the economic benefits of the use of the leased asset for the major part of its useful life in return for entering into an obligation to pay for that right an amount approximating to the fair value of the asset and the related finance charge. Hence, the finance lease gives rise to items that satisfy the definition of an asset and a liability and are recognised as such in the lessee’s balance sheet (Framework para 51). Thus, the Framework stresses economic substance over legal form and reminds us that not all assets and liabilities will meet the criteria for recognition. Many assets, for example, property, plant and equipment, have a physical form. However, physical form is not essential to the existence of an asset; hence patents and copyrights, for example, are assets if future economic benefits are expected to flow from them to the entity and if they are controlled by the entity (Framework para 56). Many assets, for example, receivables and property, are associated with legal rights, including the right of ownership. In determining the existence of an asset, the right of ownership is not essential; thus, for example, property held on a lease is an asset if the entity controls the benefits which are expected to flow from the property. Although the capacity of an entity to control benefits is usually the result of legal rights, an item may nonetheless satisfy the definition of an asset even when there is no legal control. For example, know-how obtained from a development activity may meet the definition of an asset when, by keeping that know-how secret, an entity controls the benefits that are expected to flow from it (Framework para 57). The assets of an entity result from past transactions or other past events. Entities normally obtain assets by purchasing or producing them, but other transactions or events may generate assets; examples include property received by an entity from the government as part of a programme to encourage economic growth in an area and the discovery of mineral deposits. Transactions or events expected to occur in the future do not in themselves give rise to assets; hence, for example, an intention to purchase inventory does not, of itself, meet the definition of an asset (Framework para 58). There is a close association between incurring expenditure and generating assets but the two do not necessarily coincide. Hence, when an entity incurs expenditure, this may provide evidence that future economic benefits were sought but is not con- clusive proof that an item satisfying the definition of an asset has been obtained. Similarly the absence of a related expenditure does not preclude an item from satis- fying the definition of an asset and thus becoming a candidate for recognition in the balance sheet; for example, items that have been...
Continue Reading

Please join StudyMode to read the full document

You May Also Find These Documents Helpful

  • Essay on Does Fair Value Accounting for Non-Financial Assets
  • Conceptual Framework for Financial Reporting Essay
  • Advance Financial Accounting Report Essay
  • Segment Reporting Essay
  • Essay on In depth analysis of Financial Statements BP
  • Financial Reporting Strategy Essay
  • Financial verses Managerial Accounting Essay
  • Corporate Reporting: Course Notes Essay

Become a StudyMode Member

Sign Up - It's Free