Recognition criteria

Last Updated on 12/02/2020 by 75385885

Recognition criteria

The definitions

5.6 Only items that meet the definition of an asset, a liability or equity are recognised in the statement of financial position. Similarly, only items that meet the definition of income or expenses are recognised in the statement(s) of financial performance. However, not all items that meet the definition of one of those elements are recognised. Recognition criteria

Relevant information and Faithful representation

5.7 Not recognising an item that meets the definition of one of the elements makes the statement of financial position and the statement(s) of financial performance less complete and can exclude useful information from financial statements. Recognition criteria Recognition criteria

On the other hand, in some circumstances, recognising some items that meet the definition of one of the elements would not provide useful information. An asset or liability is recognised only if recognition of that asset or liability and of any resulting income, expenses or changes in equity provides users of financial statements with information that is useful, ie with:

  1. relevant information about the asset or liability and about any resulting income, expenses or changes in equity (see the sections Relevance and Low probability of an inflow or outflow of economic benefits 5.12–5.17); and Recognition criteria Recognition criteria
  2. a faithful representation of the asset or liability and of any resulting income, expenses or changes in equity (see Faithful representation and Other factors 5.18–5.25).

Constraints in recognition decisions

5.8 Just as cost constraints other financial reporting decisions, it also constrains recognition decisions. There is a cost to recognising an asset or liability. Preparers of financial statements incur costs in obtaining a relevant measure of an asset or liability. Recognition criteria

Users of financial statements also incur costs in analysing and interpreting the information provided. An asset or liability is recognised if the benefits of the information provided to users of financial statements by recognition are likely to justify the costs of providing and using that information. In some cases, the costs of recognition may outweigh its benefits.

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Cost outweigh the benefits – Judgement needed

5.9 It is not possible to define precisely when recognition of an asset or liability will provide useful information to users of financial statements, at a cost that does not outweigh its benefits. What is useful to users depends on the item and the facts and circumstances.

Consequently, judgement is required when deciding whether to recognise an item, and thus recognition requirements may need to vary between and within Standards.

No asset recognition leads to expense incurred over time

5.10 It is important when making decisions about recognition to consider the information that would be given if an asset or liability were not recognised. For example, if no asset is recognised when expenditure is incurred, an expense is recognised. Over time, recognising the expense may, in some cases, provide useful information, for example, information that enables users of financial statements to identify trends.

Contingent liabilities or commitments

5.11 Even if an item meeting the definition of an asset or liability is not recognised, an entity may need to provide information about that item in the notes. It is important to consider how to make such information sufficiently visible to compensate for the item’s absence from the structured summary provided by the statement of financial position and, if applicable, the statement(s) of financial performance.


Recognition criteria of assets

In order for an asset to be recognized in the financial statements, it must the following definition laid down in the IASB Framework:

Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (IASB Framework).

It is worth noting that the framework defines asset in terms of control rather than ownership. While control is generally evidenced through ownership, this may not always be the case. Therefore, an asset may be recognized in the financial statement of the entity even if ownership of the asset belongs to someone else.

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For instance, if a machine is leased to a company for the entire duration of its useful life, the machine may be recognized in its Statement of Financial Position (Balance Sheet) since the entity has control over the economic benefits that would be derived from the use of the asset. This illustrates the use of Substance Over Form whereby the economic substance of the transaction takes precedence over the legal aspects of a transaction in order to present a true and fair view.

Explanation

Since, by definition, an asset must be controlled by the entity in order for it to be recognized in the financial statements, certain ‘Assets’ would not qualify for recognition. Consider a highly dedicated workforce. Generally speaking, a hardworking and motivated workforce is the most valuable asset of any successful company. But does an entity has control over its workers? The answer is no, because an employee may quit an organization any day and seek employment in a rival firm much to the detriment of the company. Therefore, such ‘Assets’ may not be recognized in the financial statements of a company.

Apart from meeting the above definition, the Framework has advised the following recognition criteria that ought to be met before an asset is recognized in the financial statements.

With regard to the first criteria, it makes sense to only recognize an asset if the benefits from its use or sale are likely. The second test ensures that the financial statements present assets that can be measured objectively. For instance, how does a person place value on something subjective such as customer loyalty or a dedicated employee?

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Last Updated on 12/02/2020 by 75385885

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). Individual jurisdictions around the world may require or permit the use of (locally authorised and/or amended) IFRS Standards for all or some publicly listed companies.  The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. The specific status of IFRS Standards should be checked in each individual jurisdiction. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

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