Chapter 6 Recognition and Measurement

RECOGNITION
The Revised Conceptual Framework defines recognition, the process of capturing for
inclusion, in, the financial statements an item that meets the definition of an asset,
liability, equity, income or expense.
The amount at which an asset, a liability or equity is recognized in the statement of

financial position is reported as carrying amount.
Recognition links the elements to the statement of financial position and statement of
financial performance.
The statements are linked because the recognition of an item in one statement requires
the recognition of the same item in another statement.
For example, the recognition of income happens simultaneously with the recognition of an
increase in asset or decrease in liability
The recognition of expense happens simultaneously with the recognition of a decrease in

asset or increase in liability.
Recognition criteria
Only items that meet the definition of an asset, a liability or equity are recognized in the
statement of financial position.
Similarly, only items that meet the definition of income or expense are recognized in the
statement of financial performance.
In addition to meeting the definition of an element, items are recognized only when their
recognition provides users of financial statements with information that is both relevant
and faithfully represented.
Recognition does not focus anymore on how probable economic benefits will flow to or
from the entity and that the cost can be measured reliably.
An asset or liability and any corresponding income or expense can exist even if the
probability of inflow or outflow of the benefits is low,
Point of sale income recognition

The basic principle of income recognition is that income shall be recognized when earned.
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But the question is when is income considered to be earned?
With respect to sale of goods in the ordinary course of business, the point of sale is
unquestionably the point of income recognition.
The reason is that it is at the point of sale that the entity has transferred to the buyer
the significant risks and rewards of ownership of the goods.
Stated differently, legal title to the goods passes to the buyer at the point of sale.
Moreover, it is at the point of sale that the entity has transferred control of the goods
to the customer.
However, under certain conditions, income may be recognized at the point of production,
during production and at the point of collection.
Expense recognition
The basic expense recognition means that expenses are recognized when incurred.
But the question is when are expenses incurred?
Actually, the expense recognition principle is the application of the matching principle.
The generation of revenue is not without any cost. There has got to be some cost in
earning a revenue.
"There is no gain if there is no pain".
The matching principle requires that those costs and expenses incurred in earning a
revenue shall be reported in the same period.
The matching principle has three applications, namely:

a. Cause and effect association
b. Systematic and rational allocation
c. Immediate recognition
Cause and effect association

Under this principle, the expense is recognized when the revenue is already recognized.
The reason is the presumed direct association of the expense with specific items of
income This is actually the "strict matching concept"
This process, commonly referred to as the matching of cost with revenue, involves the
simultaneous or combined recognition of revenue and expenses that result directly and
jointly from the same transactions or events.
The best example is the cost of merchandise inventory.

Such cost is considered as an asset in the meantime that the merchandise is on hand.
When the merchandise is sold, the cost thereof is expensed in the form of "cost of
goods sold" because at such time revenue may be recognized.
Other examples include doubtful accounts, warranty expense and sales commissions.
Systematic and rational allocation

Under this principle, some costs are expensed by simply allocating them over the periods
benefited,
The reason for this principle is that the cost incurred will benefit future periods and
that there is an absence of a direct or clear association of the expense with specific
revenue.
When economic benefits are expected to arise over several accounting periods and the
association with income can only be broadly or indirectly determined, expenses are
recognized on the basis of systematic and allocation procedures.
Concrete examples include depreciation of property, plant and equipment, amortization of

intangibles, and allocation of prepaid rent, insurance and other prepayments.
Immediate recognition
Under this principle, the cost incurred is expensed outright because of uncertainty of
future economic benefits or difficulty of reliably associating certain costs with future
revenue.
An expense is recognized immediately:

a. When an expenditure produces no future economic benefit.
b. When cost incurred does not qualify or ceases to qualify for recognition as an asset.
Examples include officers’ salaries and most administrative expenses, advertising and
most selling expenses, amount to settle lawsuit and worthless intangibles.
Many losses, such as loss from disposal of building, loss from sale of investments, and
casualty loss, are immediately recognized because they are not directly related to
specific revenue.
Derecognition
The Revised Conceptual Framework introduced the term derecognition.
Derecognition is defined as the removal of all or part of a recognized asset or liability

from the statement of financial position.
Derecognition normally occurs when an item no longer meets the definition of an asset or
a liability.
Derecognition of an asset occurs when the entity loses control of all or part of the asset.
Derecognition of a liability occurs when the entity no longer has a present obligation for
all or part of the liability.
MEASUREMENT
Measurement is defined as quantifying in, monetary terms the elements in the financial
statements.
The Revised Conceptual Framework mentions two categories:
a. Historical cost
b. Current value
HISTORICAL COST
The historical cost or original acquisition cost of an asset is the cost incurred in acquiring
or creating the asset comprising the consideration paid plus transaction cost.
The historical cost of a liability is the consideration received to incur the liability minus
transaction cost.
Simply stated, historical cost is the entry price or entry value to acquire an asset or to
incur a liability.
An application of the historical cost measurement is to measure financial asset and

financial liability at amortized cost.
The amortized cost reflects the estimate of future cash flows discounted at a rate
determined at initial recognition.
Historical cost updated
1. Historical cost of an asset is updated because of:
a. Depreciation and amortization

b. Payment received as a result of disposing part or all of the asset
c. Impairment
d. Accrual of interest to reflect any financing component of the asset
e. Amortized cost measurement of financial asset
2. Historical cost of a liability is updated because of:

a. Payment made or satisfying an obligation to deliver goods
b. Increase in value of the obligation to transfer economic resources such
that the liability becomes onerous
c. Accrual of interest to reflect any financing component of the liability
d. Amortized cost measurement of financial liability
CURRENT VALUE
Current value includes:
a. Fair value
b. Value in use for asset
c. Fulfillment value for liability
d. Current cost
Fair value
Fair value of an asset is the price that would be received to sell an asset in an orderly
transaction between market participants at measurement date.
Fair value of liability is the price that would paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
Fair value is an exit price or exit value.
Fair value can be observed directly using market price of the asset or liability in an active
market.
In cases where fair value cannot be directly measured, an entity can use present value of
cash flows.
Fair value is not adjusted for transaction cost. The reason is that such cost is a
characteristic of the transaction and not of the asset or liability.
Value in use
Value in use is the present value of the cash flows that an entity expects to derive from
the use of an asset and from the ultimate disposal.
Value in use does not include transaction cost on acquiring the asset but includes
transaction cost on the disposal of the asset.
Value in use is an exit price or exit value.
Fulfillment value
Fulfillment value is the present value of cash that an entity expects to transfer in paying
or settling a liability.
Fulfillment value does not include transaction cost on incurring a liability but includes
transaction cost on fulfillment of a liability.
Fulfillment value is an exit price or exit value.
Current cost
Current cost of an asset is the cost of an equivalent asset at the measurement date
comprising the consideration paid and transaction cost.
Current cost of a liability is the consideration that would be received less any transaction
cost at measurement date.
Similar to historical cost, current cost is also based on the entry price or entry value but
reflects market conditions on measurement date.
Selecting a measurement basis

In selecting a measurement basis for an asset or a liability and for the related income
and expense, it is necessary to consider the nature of the information that the
measurement basis will produce.
In most cases, no single factor will determine which measurement basis should be
selected.
The relative importance of each factor will depend on facts and circumstances.
The information produced by the measurement basis must be useful to the users of
financial statements. To achieve this, the information must be both relevant and
faithfully represented.
Historical cost is the measurement basis most commonly adopted in preparing financial
statements.
In many situations, it is simpler and less costly to measure historical cost than it is to
measure a current value.
In addition, historical cost is generally well understood and verifiable.
The IASB did not mandate a single measurement basis because the different
measurement bases could produce useful information under different circumstances.

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RECOGNITION

The amount at which an asset, a liability or equity is recognized in the statement of

The recognition of expense happens simultaneously with the recognition of a decrease in

Point of sale income recognition

But the question is when are expenses incurred?

"There is no gain if there is no pain".

The matching principle has three applications, namely:

Cause and effect association

The best example is the cost of merchandise inventory.

Systematic and rational allocation

Concrete examples include depreciation of property, plant and equipment, amortization of

An expense is recognized immediately:

Derecognition is defined as the removal of all or part of a recognized asset or liability

An application of the historical cost measurement is to measure financial asset and

a. Depreciation and amortization

2. Historical cost of a liability is updated because of:

Fulfillment value is an exit price or exit value.

Selecting a measurement basis

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