UNDERSTANDING ASSETS AND LIABILITIES
27 May 2011
The IASB’s Framework for the Preparation and Presentation of Financial Statements (The Framework) defines an asset as ‘a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity’.
This means that control instead of ownership is the determining factor. This allows assets that are not legally owned by an entity, but over which the entity has the right to use or occupy the assets, to be recognised as assets of the entity.
This means that control instead of ownership is the determining factor. This allows assets that are not legally owned by an entity, but over which the entity has the right to use or occupy the assets, to be recognised as assets of the entity.
The essence of this approach is therefore the right to enjoy the future economic benefits that the asset will produce (normally future cash flows). A good example of this type of arrangement is a finance lease.
Control not only allows the entity to obtain the economic benefits of assets but also to restrict the access of others to them. Where an entity develops an alternative manufacturing process that reduces future cash outflows in terms of lower cost of production, this too can be an asset.
Assets can also arise where there is no legal control. The Framework gives the example of ‘know-how’ derived from a development activity. Where an entity has the capacity to keep this a secret, the entity controls the benefits that are expected to flow from it. These are recognised as intangible assets under IAS 38 Intangible assets.
The Framework defines a liability as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.’. The Framework stresses that the essential characteristic is the ‘present obligation’.
Most liabilities are legal or contractual obligations to transfer known amounts of cash, e.g. trade payables and loans. Occasionally they may be settled other than for cash such as in a barter transaction, but this still constitutes transferring economic benefits.
Liabilities can also arise through constructive obligations. These occur where an entity creates a valid expectation that it will discharge responsibilities that it is not legally obliged to. This is usually as a result of past behaviour, or by commitments given in a published statement (e.g. voluntarily incurring environmental costs). Where the exact amount of a liability is uncertain it is usually referred to as a provision.
Obligations may also exist that are not expected to require ‘transfers of economic benefits’. These are known as contingent liabilities. For example, where a holding company guarantees a subsidiary’s loan.
Most liabilities are legal or contractual obligations to transfer known amounts of cash, e.g. trade payables and loans. Occasionally they may be settled other than for cash such as in a barter transaction, but this still constitutes transferring economic benefits.
Liabilities can also arise through constructive obligations. These occur where an entity creates a valid expectation that it will discharge responsibilities that it is not legally obliged to. This is usually as a result of past behaviour, or by commitments given in a published statement (e.g. voluntarily incurring environmental costs). Where the exact amount of a liability is uncertain it is usually referred to as a provision.
Obligations may also exist that are not expected to require ‘transfers of economic benefits’. These are known as contingent liabilities. For example, where a holding company guarantees a subsidiary’s loan.
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