Constraints on Relevant and Reliable
- Timeliness – Undue delay in reporting of information may make it lose its relevance. Hence, Management should ensure that information is provided on timely basis. However, some information may not be available at time to be completely reliable and Management will have to strike a balance between waiting for complete reliable information or present information on timely basis. It is to be noted that although reliability is an important characteristics of information, a complete reliable information if presented delayed can often be non-relevant.
- Balance between Benefit and Cost
- Balance between Qualitative Characteristics
True and Fair View
Financial Statements are often described as showing a true and fair view of the financial position, performance and cash flows of an enterprise. Although this Framework does not deal directly with such concepts, the application of the principal qualitative characteristics and of appropriate accounting standards normally results in financial statements that convey what is generally understood as a true and fair view of such information.
The Elements of Financial Statements
Financial statements portray the financial effects of transactions and other events by grouping them into broad classes according to their economic characteristics. These broad classes are termed the elements of financial statements. The elements directly related to the measurement of financial position in the balance sheet are assets, liabilities and equity. The elements directly related to the measurement of performance in the statement of profit and loss are income and expenses. The cash flow statement usually reflects elements of statement of profit and loss and changes in balance sheet elements; accordingly, this Framework identifies no elements that are unique to this statement. The presentation of these elements in the balance sheet and the statement of profit and loss involves a process of sub classification. For example, assets and liabilities may be classified by their nature or function in the business of the enterprise in order to display information in the manner most useful to users for purposes of making economic decisions.
Financial Position
The elements directly related to the measurement of financial position are assets, liabilities and equity. These are defined as follows –
- An Assets is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.
- A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
- Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.
Assets
The future economic benefit embodied in an asset is the potential to contribute, directly or indirectly, to the flow of cash and cash equivalents to the enterprise. There must be such future benefits to let any resource be classified as asset and be recognised. This future economic benefits embodied in an asset may flow to the enterprise in a number of ways. For example, an asset may be –
- Used singly or in combination with other assets in the production of goods or services to be sold by the enterprise;
- Exchanged for other assets;
- Used to settle a liability; or
- Distributed to the owners of the enterprise.
Although most of the assets have physical presence such as Plants and Machinery, Physical form is not essential to the existence of an asset. Hence, patents and copyrights or other intangible assets are also assets provided they are controlled by the enterprise and there is expected flow of benefits in future.
Also mere legal form such as legal deeds, registration, etc. do not meet essential criteria for recognition. What is more important is not the ownership tittle, but the control exercised by the enterprise. This is why even though items purchased under hire purchase may not be under enterprise’s legal title, still they are assets of the enterprise because it exercised complete control over it. One of the most important characteristics of an asset is that it results from past expenditure incurred by the enterprise. For example, although Land is not transferred under legal title of the enterprise, when payment is made and it is almost sure there doesn’t lies any contingencies, enterprise is capable of recognising it as its asset. However, where no expenditure is made and mere intention is there to buy an inventory, it cannot recognise such inventory as its assets. It is therefore that there lies essential relationship between expenditure and the assets. In fact, it acts as a proof of existence of asset.
Liabilities
An important characteristic of a liability is that the enterprise has a present obligation. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. Although liabilities arise in normally from contracts or statutory requirement, it may also arise from normal business practice, custom and desire to maintain good business relations or act in an equitable manner. If, for example, an enterprise decides as a matter of policy to rectify faults in its products even when these become apparent after the warranty period has expired, the amounts that are expected to be expended in respect of goods already sold are liabilities.
A distinction needs to be drawn between a present obligation and a future commitment. A decision by the management of an enterprise to acquire assets in the future does not, of itself, give rise to a present obligation. An obligation normally arises only when the asset is delivered or the enterprise enters into an irrevocable agreement to acquire the asset. In the latter case, the irrevocable nature of the agreement means that the economic consequences of failing to honour the obligation, for example because of the existence of a substantial penalty, leave the enterprise with little, if any, discretion to avoid the outflow of resources to another party.
The settlement of a present obligation usually involves the enterprise giving up resources embodying economic benefits in order to satisfy the claim of the other party. Settlement of a present obligation may occur in a number of ways, for example, by-
- Payment of cash;
- Transfer of other assets;
- Provision of services;
- Replacement of that obligation with another obligation; or
- Conversion of the obligation to equity.
An obligation may also be extinguished by other means, such as a creditor waiving or forfeiting its rights.
Liabilities result from past transactions or other past events. Thus, for example, the acquisition of goods and the use of services give rise to trade creditors (unless paid for in advance or on delivery) and the receipt of a bank load results in an obligation to repay the loan. An enterprise may also recognise future rebates based on annual purchases by customers as liabilities; in this case, the sale of the goods in the past is the transaction that give rise to the liability. Some liabilities can be measured only by using a substantial degree of estimation. Such liabilities are commonly described as ‘provisions’. Examples include provisions for payments to be made under existing warranties and provisions to cover pension obligations.