RECOGNITION AND MEASUREMENT Concepts and Principles

RECOGNITION AND MEASUREMENT (Concepts and Principles) of ELEMENTS of Financial Statements

IFRS/PFRS sets out recognition and measurement requirements dealing with transactions and events.

Recognition Concepts

• Definition of Recognition 

Recognition is the process of incorporating in the statement of financial position or income statement an item that meets the definition of an element and satisfies the criteria for recognition.

An item that meets the definition of an element should be recognized if:

a. it is probable that any future economic benefit associated with the item will flow to or from the entity; and 

b. the item has a cost or value that can be measured with reliability.  

• Recognition of Assets  

An asset is recognized in the statement of financial position when:

a. it is probable that any future economic benefits will flow to the entity; and 

b. asset has a cost or value that can be measured reliably.  

• Recognition of Income

Income is recognized in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.

This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. For example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable. 

Realization Principle 

Realization principle is also known as the Revenue Recognition principle. 

Realization principle guides when to recognize the revenue. 

GAAP requires that two criteria must be satisfied in recognizing revenue...read more

• Recognition of Expenses    

Element is recognized in the income statement when a decrease on future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.  

This means, in effect, that recognition of expenses occurs simultaneously with the recognition of an increases in liabilities or a decrease in assets. For example, accrual of employee entitlements or the depreciation of equipment.

Matching Principle 

Matching principle states that expenses are recognized in the same period as the related revenues are recognized.  Meaning, expenses recognition is driven by a matching process. 

There’s a relationship between the realization principle and matching principle.  When revenue is recognized in a particular period, all the expenses incurred in generating such revenue must also be recognized...read more

Measurement Principles

• Definition of Measurement 

Measurement is the process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the statement of financial position and income statement.

This involves the selection of the particular basis of measurement.  A number of different measurement bases are employed to different degrees and in varying combinations in financial statements. 

Measurement bases are the following: 

• Historical Cost 

Assets are recorded at the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.

Liabilities are recorded at the amount of proceeds received in exchange for the obligations, or in some circumstances at the amounts of cash or cash equivalents expected to be paid to satisfy the liability in the normal course of business. 

Historical Cost Principle 

PAS and GAAP recognized that elements of Assets and Liabilities are measured based on their original transaction value.  And, this is their historical cost...read more 

• Current Cost 

Assets are carried at the amount of cash or cash equivalents that would have to be paid if the same or an equivalent asset was acquired currently.

Liabilities are carried at an undiscounted amount of cash or cash equivalents that would be required to settle the obligation currently.   

• Realizable (settlement) Value 

Assets are carried at the amount of cash or cash equivalents that could currently be obtained by selling the asset in an orderly disposal. 

Liabilities are carried at their settlement values; that is, the undiscounted amounts of cash or cash equivalents expected to be paid to satisfy the liabilities in the normal course of business.

• Present Value   

Assets are carried at the present discounted value of the future net cash inflows that the item is expected to generate in the normal course of business. 

Liabilities are carried at their present discounted value of the future net cash outflows that are expected to be required to settle the liabilities in the normal course of business.

Source: IFRS-PFRS

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Matching Principle

Matching principle gives guidance as to when expenses are recognized.

Matching principle states that expenses are recognized in the same period as the related revenues are recognized.  Meaning, expenses recognition is driven by a matching process.

There’s a relationship between the realization principle and matching principle.  When revenue is recognized in a particular period, all the expenses incurred in generating such revenue must also be recognized.

Note that not all expenses are directly caused by generating revenues. There are expenses which are incurred but indirectly associated to generate revenue.

Approaches in recognizing expenses are as follows:

1. Some expenses are recognized based on the exact cause-and-effect between revenue and expense event. 

There is a cause-and-effect relationship or direct relationship between revenues and expenses.
Such expenses pertain to the cost to sell or cost to produce goods and services. 

These are the cost of service or cost of goods sold or cost of sales. 

Another example for this approach is the sales commission paid for obtaining revenues.

2.  By associating the expenses with the revenues recognized in a particular period. 

There are expenses which are not directly cause by a revenue event.  However, some expenses can be related to the time period during which the revenue is earned.

For example, the monthly salary paid to employees is not directly associated to any revenue event. Employees render services during the month and indirectly relate to the recognized revenue in that period.

3.  By systematic and rational allocations to specific time periods. 

Some expenses are recognized or allocated to a specific time period.  There are costs which are incurred to acquire assets that benefit more than one reporting period.  Such costs are systematically and rationally allocated periodically. 

Examples are the systematic and rational allocations of some prepaid expenses, depreciation and amortization expenses.

4.  In the period incurred, without regard to related revenues.  

This approach is called for in situations when costs are incurred but it is not possible to determine in which time periods to recognize.   

Example is the marketing and advertising expenses.  It is difficult to determine how much is expended in generating incremental revenues.  Because of this, such marketing and advertising expenditures are recognized at the period they are incurred.

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