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AS Framework 2025

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Framework for the Preparation and Presentation of
Financial Statements*
The following is the text of the ‘Framework for the Preparation and Presentation
of Financial Statements’ issued by the Accounting Standards Board of the
Institute of Chartered Accountants of India.

Introduction
Purpose and Status
1. This Framework sets out the concepts that underlie the preparation and
presentation of financial statements for external users. The purpose of the
Framework is to:

(a) assist preparers of financial statements in applying Accounting
Standards and in dealing with topics that have yet to form the subject
of an Accounting Standard;

(b) assist the Accounting Standards Board in the development of future
Accounting Standards and in its review of existing Accounting
Standards;

(c) assist the Accounting Standards Board in promoting harmonisation
of regulations, accounting standards and procedures relating to the
preparation and presentation of financial statements by providing a
basis for reducing the number of alternative accounting treatments
permitted by Accounting Standards;

(d) assist auditors in forming an opinion as to whether financial
statements conform with Accounting Standards;

(e) assist users of financial statements in interpreting the information
contained in financial statements prepared in conformity with
Accounting Standards; and

(f) provide those who are interested in the work of the Accounting
Standards Board with information about its approach to the
formulation of Accounting Standards.

* Issued in July 2000.
Framework for the Preparation and Presentation of Financial Statements

2. This Framework is not an Accounting Standard and hence does not define
standards for any particular measurement or disclosure issue. Nothing in this
Framework overrides any specific Accounting Standard.

3. The Accounting Standards Board recognises that in a limited number of
cases there may be a conflict between the Framework and an Accounting
Standard. In those cases where there is a conflict, the requirements of the
Accounting Standard prevail over those of the Framework. As, however, the
Accounting Standards Board will be guided by the Framework in the
development of future Standards and in its review of existing Standards, the
number of cases of conflict between the Framework and Accounting Standards
will diminish through time.

4. The Framework will be revised from time to time on the basis of the
experience of the Accounting Standards Board of working with it.

Scope

5. The Framework deals with:

(a) the objective of financial statements;
(b) the qualitative characteristics that determine the usefulness of
information provided in financial statements;
(c) definition, recognition and measurement of the elements from which
financial statements are constructed; and
(d) concepts of capital and capital maintenance.

6. The Framework is concerned with general purpose financial statements
(hereafter referred to as ‘financial statements’). Such financial statements are
prepared and presented at least annually and are directed toward the common
information needs of a wide range of users. Some of these users may require,
and have the power to obtain, information in addition to that contained in the
financial statements. Many users, however, have to rely on the financial
statements as their major source of financial information and such financial
statements should, therefore, be prepared and presented with their needs in
view. Special purpose financial reports, for example, prospectuses and
computations prepared for taxation purposes, are outside the scope of this
Framework. Nevertheless, the Framework may be applied in the preparation of
such special purpose reports where their requirements permit.

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Framework for the Preparation and Presentation of Financial Statements

7. Financial statements form part of the process of financial reporting. A
complete set of financial statements normally includes a balance sheet, a
statement of profit and loss (also known as ‘income statement’), a cash flow
statement and those notes and other statements and explanatory material that
are an integral part of the financial statements. They may also include
supplementary schedules and information based on or derived from, and
expected to be read with, such statements. Such schedules and supplementary
information may deal, for example, with financial information about business and
geographical segments, and disclosures about the effects of changing prices.
Financial statements do not, however, include such items as reports by directors,
statements by the chairman, discussion and analysis by management and similar
items that may be included in a financial or annual report.

8. The Framework applies to the financial statements of all reporting
enterprises engaged in commercial, industrial and business activities, whether in
the public or in the private sector. A reporting enterprise is an enterprise for
which there are users who rely on the financial statements as their major source
of financial information about the enterprise.

Users and Their Information Needs

9. The users of financial statements include present and potential investors,
employees, lenders, suppliers and other trade creditors, customers, governments
and their agencies and the public. They use financial statements in order to
satisfy some of their information needs. These needs include the following:

(a) Investors. The providers of risk capital are concerned with the risk
inherent in, and return provided by, their investments. They need
information to help them determine whether they should buy, hold or
sell. They are also interested in information which enables them to
assess the ability of the enterprise to pay dividends.

(b) Employees. Employees and their representative groups are
interested in information about the stability and profitability of their
employers. They are also interested in information which enables
them to assess the ability of the enterprise to provide remuneration,
retirement benefits and employment opportunities.

(c) Lenders. Lenders are interested in information which enables them
to determine whether their loans, and the interest attaching to them,
will be paid when due.

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Framework for the Preparation and Presentation of Financial Statements

(d) Suppliers and other trade creditors. Suppliers and other creditors are
interested in information which enables them to determine whether
amounts owing to them will be paid when due. Trade creditors are
likely to be interested in an enterprise over a shorter period than
lenders unless they are dependent upon the continuance of the
enterprise as a major customer.

(e) Customers. Customers have an interest in information about the
continuance of an enterprise, especially when they have a long- term
involvement with, or are dependent on, the enterprise.

(f) Governments and their agencies. Governments and their agencies
are interested in the allocation of resources and, therefore, the
activities of enterprises. They also require information in order to
regulate the activities of enterprises and determine taxation policies,
and to serve as the basis for determination of national income and
similar statistics.

(g) Public. Enterprises affect members of the public in a variety of ways.
For example, enterprises may make a substantial contribution to the
local economy in many ways including the number of people they
employ and their patronage of local suppliers. Financial statements
may assist the public by providing information about the trends and
recent developments in the prosperity of the enterprise and the range
of its activities.

10. While all of the information needs of these users cannot be met by financial
statements, there are needs which are common to all users. As providers of risk
capital to the enterprise, investors need more comprehensive information than
other users. The provision of financial statements that meet their needs will also
meet most of the needs of other users that financial statements can satisfy.

11. The management of an enterprise has the responsibility for the preparation
and presentation of the financial statements of the enterprise. Management is
also interested in the information contained in the financial statements even
though it has access to additional management and financial information that
helps it carry out its planning, decision-making and control responsibilities.
Management has the ability to determine the form and content of such additional
information in order to meet its own needs. The reporting of such information,
however, is beyond the scope of this Framework.

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Framework for the Preparation and Presentation of Financial Statements

The Objective of Financial Statements
12. The objective of financial statements is to provide information about the
financial position, performance and cash flows of an enterprise that is useful to a
wide range of users in making economic decisions.

13. Financial statements prepared for this purpose meet the common needs of
most users. However, financial statements do not provide all the information that
users may need to make economic decisions since (a) they largely portray the
financial effects of past events, and (b) do not necessarily provide non-financial
information.

14. Financial statements also show the results of the stewardship of
management, or the accountability of management for the resources entrusted to
it. Those users who wish to assess the stewardship or accountability of
management do so in order that they may make economic decisions; these
decisions may include, for example, whether to hold or sell their investment in
the enterprise or whether to reappoint or replace the management.

Financial Position, Performance and Cash Flows

15. The economic decisions that are taken by users of financial statements
require an evaluation of the ability of an enterprise to generate cash and cash
equivalents and of the timing and certainty of their generation. This ability
ultimately determines, for example, the capacity of an enterprise to pay its
employees and suppliers, meet interest payments, repay loans, and make
distributions to its owners. Users are better able to evaluate this ability to
generate cash and cash equivalents if they are provided with information that
focuses on the financial position, performance and cash flows of an enterprise.

16. The financial position of an enterprise is affected by the economic
resources it controls, its financial structure, its liquidity and solvency, and its
capacity to adapt to changes in the environment in which it operates. Information
about the economic resources controlled by the enterprise and its capacity in the
past to alter these resources is useful in predicting the ability of the enterprise to
generate cash and cash equivalents in the future. Information about financial
structure is useful in predicting future borrowing needs and how future profits and
cash flows will be distributed among those with an interest in the enterprise; it is
also useful in predicting how successful the enterprise is likely to be in raising
further finance. Information about liquidity and solvency is useful in predicting the
ability of the enterprise to meet its financial commitments as they fall due.
Liquidity refers to the availability of cash in the near future to meet financial

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Framework for the Preparation and Presentation of Financial Statements

commitments over this period. Solvency refers to the availability of cash over the
longer term to meet financial commitments as they fall due.

17. Information about the performance of an enterprise, in particular its
profitability, is required in order to assess potential changes in the economic
resources that it is likely to control in the future. Information about variability of
performance is important in this respect. Information about performance is useful
in predicting the capacity of the enterprise to generate cash flows from its
existing resource base. It is also useful in forming judgements about the
effectiveness with which the enterprise might employ additional resources.

18. Information concerning cash flows of an enterprise is useful in order to
evaluate its investing, financing and operating activities during the reporting
period. This information is useful in providing the users with a basis to assess the
ability of the enterprise to generate cash and cash equivalents and the needs of
the enterprise to utilise those cash flows.

19. Information about financial position is primarily provided in a balance sheet.
Information about performance is primarily provided in a statement of profit and
loss. Information about cash flows is provided in the financial statements by
means of a cash flow statement.

20. The component parts of the financial statements are interrelated because
they reflect different aspects of the same transactions or other events. Although
each statement provides information that is different from the others, none is
likely to serve only a single purpose nor to provide all the information necessary
for particular needs of users.

Notes and Supplementary Schedules

21. The financial statements also contain notes and supplementary schedules
and other information. For example, they may contain additional information that
is relevant to the needs of users about the items in the balance sheet and
statement of profit and loss. They may include disclosures about the risks and
uncertainties affecting the enterprise and any resources and obligations not
recognised in the balance sheet (such as mineral reserves). Information about
business and geographical segments and the effect of changing prices on the
enterprise may also be provided in the form of supplementary information.

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Framework for the Preparation and Presentation of Financial Statements

Underlying Assumptions
Accrual Basis

22. In order to meet their objectives, financial statements are prepared on the
accrual basis of accounting. Under this basis, the effects of transactions and
other events are recognised when they occur (and not as cash or a cash
equivalent is received or paid) and they are recorded in the accounting records
and reported in the financial statements of the periods to which they relate.
Financial statements prepared on the accrual basis inform users not only of past
events involving the payment and receipt of cash but also of obligations to pay
cash in the future and of resources that represent cash to be received in the
future. Hence, they provide the type of information about past transactions and
other events that is most useful to users in making economic decisions.

Going Concern

23. The financial statements are normally prepared on the assumption that an
enterprise is a going concern and will continue in operation for the foreseeable
future. Hence, it is assumed that the enterprise has neither the intention nor the
need to liquidate or curtail materially the scale of its operations; if such an
intention or need exists, the financial statements may have to be prepared on a
different basis and, if so, the basis used is disclosed.

Consistency

24. In order to achieve comparability of the financial statements of an
enterprise through time, the accounting policies are followed consistently from
one period to another; a change in an accounting policy is made only in certain
exceptional circumstances.

Qualitative Characteristics of Financial Statements

25. Qualitative characteristics are the attributes that make the information
provided in financial statements useful to users. The four principal qualitative
characteristics are understandability, relevance, reliability and comparability.

Understandability

26. An essential quality of the information provided in financial statements is
that it must be readily understandable by users. For this purpose, it is assumed

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Framework for the Preparation and Presentation of Financial Statements

that users have a reasonable knowledge of business and economic activities and
accounting and study the information with reasonable diligence. Information
about complex matters that should be included in the financial statements
because of its relevance to the economic decision-making needs of users should
not be excluded merely on the ground that it may be too difficult for certain users
to understand.

Relevance

27. To be useful, information must be relevant to the decision-making needs of
users. Information has the quality of relevance when it influences the economic
decisions of users by helping them evaluate past, present or future events or
confirming, or correcting, their past evaluations.

28. The predictive and confirmatory roles of information are interrelated. For
example, information about the current level and structure of asset holdings has
value to users when they endeavour to predict the ability of the enterprise to take
advantage of opportunities and its ability to react to adverse situations. The same
information plays a confirmatory role in respect of past predictions about, for
example, the way in which the enterprise would be structured or the outcome of
planned operations.

29. Information about financial position and past performance is frequently
used as the basis for predicting future financial position and performance and
other matters in which users are directly interested, such as dividend and wage
payments, share price movements and the ability of the enterprise to meet its
commitments as they fall due. To have predictive value, information need not be
in the form of an explicit forecast. The ability to make predictions from financial
statements is enhanced, however, by the manner in which information on past
transactions and events is displayed. For example, the predictive value of the
statement of profit and loss is enhanced if unusual, abnormal and infrequent
items of income and expense are separately disclosed.

Materiality

30. The relevance of information is affected by its materiality. Information is
material if its misstatement (i.e., omission or erroneous statement) could
influence the economic decisions of users taken on the basis of the financial
information. Materiality depends on the size and nature of the item or error,
judged in the particular circumstances of its misstatement. Materiality provides a
threshold or cut-off point rather than being a primary qualitative characteristic
which the information must have if it is to be useful.

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Framework for the Preparation and Presentation of Financial Statements

Reliability

31. To be useful, information must also be reliable. Information has the quality
of reliability when it is free from material error and bias and can be depended
upon by users to represent faithfully that which it either purports to represent or
could reasonably be expected to represent.

32. Information may be relevant but so unreliable in nature or representation
that its recognition may be potentially misleading. For example, if the validity and
amount of a claim for damages under a legal action against the enterprise are
highly uncertain, it may be inappropriate for the enterprise to recognise the
amount of the claim in the balance sheet, although it may be appropriate to
disclose the amount and circumstances of the claim.

Faithful Representation

33. To be reliable, information must represent faithfully the transactions and
other events it either purports to represent or could reasonably be expected to
represent. Thus, for example, a balance sheet should represent faithfully the
transactions and other events that result in assets, liabilities and equity of the
enterprise at the reporting date which meet the recognition criteria.

34. Most financial information is subject to some risk of being less than a
faithful representation of that which it purports to portray. This is not due to bias,
but rather to inherent difficulties either in identifying the transactions and other
events to be measured or in devising and applying measurement and
presentation techniques that can convey messages that correspond with those
transactions and events. In certain cases, the measurement of the financial
effects of items could be so uncertain that enterprises generally would not
recognise them in the financial statements; for example, although most
enterprises generate goodwill internally over time, it is usually difficult to identify
or measure that goodwill reliably. In other cases, however, it may be relevant to
recognise items and to disclose the risk of error surrounding their recognition and
measurement.

Substance Over Form

35. If information is to represent faithfully the transactions and other events that
it purports to represent, it is necessary that they are accounted for and presented
in accordance with their substance and economic reality and not merely their
legal form. The substance of transactions or other events is not always
consistent with that which is apparent from their legal or contrived form. For

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Framework for the Preparation and Presentation of Financial Statements

example, where rights and beneficial interest in an immovable property are
transferred but the documentation and legal formalities are pending, the
recording of acquisition/disposal (by the transferee and transferor respectively)
would in substance represent the transaction entered into.

Neutrality

36. To be reliable, the information contained in financial statements must be
neutral, that is, free from bias. Financial statements are not neutral if, by the
selection or presentation of information, they influence the making of a decision
or judgement in order to achieve a predetermined result or outcome.

Prudence

37. The preparers of financial statements have to contend with the
uncertainties that inevitably surround many events and circumstances, such as
the collectability of receivables, the probable useful life of plant and machinery,
and the warranty claims that may occur. Such uncertainties are recognised by
the disclosure of their nature and extent and by the exercise of prudence in the
preparation of the financial statements. Prudence is the inclusion of a degree of
caution in the exercise of the judgements needed in making the estimates
required under conditions of uncertainty, such that assets or income are not
overstated and liabilities or expenses are not understated. However, the exercise
of prudence does not allow, for example, the creation of hidden reserves or
excessive provisions, the deliberate understatement of assets or income, or the
deliberate overstatement of liabilities or expenses, because the financial
statements would then not be neutral and, therefore, not have the quality of
reliability.

Completeness

38. To be reliable, the information in financial statements must be complete
within the bounds of materiality and cost. An omission can cause information to
be false or misleading and thus unreliable and deficient in terms of its relevance.

Comparability

39. Users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position, performance and
cash flows. Users must also be able to compare the financial statements of
different enterprises in order to evaluate their relative financial position,
performance and cash flows. Hence, the measurement and display of the

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Framework for the Preparation and Presentation of Financial Statements

financial effects of like transactions and other events must be carried out in a
consistent way throughout an enterprise and over time for that enterprise and in
a consistent way for different enterprises.

40. An important implication of the qualitative characteristic of comparability is
that users be informed of the accounting policies employed in the preparation of
the financial statements, any changes in those policies and the effects of such
changes. Users need to be able to identify differences between the accounting
policies for like transactions and other events used by the same enterprise from
period to period and by different enterprises. Compliance with Accounting
Standards, including the disclosure of the accounting policies used by the
enterprise, helps to achieve comparability.

41. The need for comparability should not be confused with mere uniformity
and should not be allowed to become an impediment to the introduction of
improved accounting standards. It is not appropriate for an enterprise to continue
accounting in the same manner for a transaction or other event if the policy
adopted is not in keeping with the qualitative characteristics of relevance and
reliability. It is also inappropriate for an enterprise to leave its accounting policies
unchanged when more relevant and reliable alternatives exist.

42. Users wish to compare the financial position, performance and cash flows
of an enterprise over time. Hence, it is important that the financial statements
show corresponding information for the preceding period(s).

Constraints on Relevant and Reliable Information

Timeliness

43. If there is undue delay in the reporting of information it may lose its
relevance. Management may need to balance the relative merits of timely
reporting and the provision of reliable information. To provide information on a
timely basis it may often be necessary to report before all aspects of a
transaction or other event are known, thus impairing reliability. Conversely, if
reporting is delayed until all aspects are known, the information may be highly
reliable but of little use to users who have had to make decisions in the interim.
In achieving a balance between relevance and reliability, the overriding
consideration is how best to satisfy the information needs of users.

Balance between Benefit and Cost

44. The balance between benefit and cost is a pervasive constraint rather than

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Framework for the Preparation and Presentation of Financial Statements

a qualitative characteristic. The benefits derived from information should exceed
the cost of providing it. The evaluation of benefits and costs is, however,
substantially a judgmental process. Furthermore, the costs do not necessarily fall
on those users who enjoy the benefits. Benefits may also be enjoyed by users
other than those for whom the information is prepared. For these reasons, it is
difficult to apply a cost-benefit test in any particular case. Nevertheless,
standard-setters in particular, as well as the preparers and users of financial
statements, should be aware of this constraint.

Balance between Qualitative Characteristics

45. In practice, a balancing, or trade-off, between qualitative characteristics is
often necessary. Generally the aim is to achieve an appropriate balance among
the characteristics in order to meet the objective of financial statements. The
relative importance of the characteristics in different cases is a matter of
professional judgment.

True and Fair View

46. Financial statements are frequently 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
47. 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.

48. 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

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Framework for the Preparation and Presentation of Financial Statements

enterprise in order to display information in the manner most useful to users for
purposes of making economic decisions.

Financial Position

49. The elements directly related to the measurement of financial position are
assets, liabilities and equity. These are defined as follows:

(a) An asset 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.

(b) 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.

50. The definitions of an asset and a liability identify their essential features but
do not attempt to specify the criteria that need to be met before they are
recognised in the balance sheet. Thus, the definitions embrace items that are not
recognised as assets or liabilities in the balance sheet because they do not
satisfy the criteria for recognition discussed in paragraphs 81 to 97. In particular,
the expectation that future economic benefits will flow to or from an enterprise
must be sufficiently certain to meet the probability criterion in paragraph 82
before an asset or liability is recognised.

51. In assessing whether an item meets the definition of an asset, liability or
equity, consideration needs to be given to its underlying substance and
economic reality and not merely its legal form. Thus, for example, in the case of
hire purchase, the substance and economic reality are that the hire purchaser
acquires the economic benefits of the use of the asset in return for entering into
an obligation to pay for that right an amount approximating to the fair value of the
asset and the related finance charge. Hence, the hire purchase gives rise to
items that satisfy the definition of an asset and a liability and are recognised as
such in the hire purchaser’s balance sheet.

Assets

52. 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

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Framework for the Preparation and Presentation of Financial Statements

enterprise. The potential may be a productive one that is part of the operating
activities of the enterprise. It may also take the form of con- vertibility into cash or
cash equivalents or a capability to reduce cash outflows, such as when an
alternative manufacturing process lowers the costs of production.

53. An enterprise usually employs its assets to produce goods or services
capable of satisfying the wants or needs of customers; because these goods or
services can satisfy these wants or needs, customers are prepared to pay for
them and hence contribute to the cash flows of the enterprise. Cash itself
renders a service to the enterprise because of its command over other
resources.

54. The future economic benefits embodied in an asset may flow to the
enterprise in a number of ways. For example, an asset may be:

(a) used singly or in combination with other assets in the production of
goods or services to be sold by the enterprise;

(b) exchanged for other assets;

(d) distributed to the owners of the enterprise.

55. Many assets, for example, plant and machinery, have a physical form.
However, physical form is not essential to the existence of an asset; hence
patents and copyrights, for example, are assets if future economic benefits are
expected to flow from them and if they are controlled by the enterprise.

56. Many assets, for example, receivables and property, are associated with
legal rights, including the right of ownership. In determining the existence of an
asset, the right of ownership is not essential; thus, for example, an item held
under a hire purchase is an asset of the hire purchaser since the hire purchaser
controls the benefits which are expected to flow from the item. Although the
capacity of an enterprise to control benefits is usually the result of legal rights, an
item may nonetheless satisfy the definition of an asset even when there is no
legal control. For example, know-how obtained from a development activity may
meet the definition of an asset when, by keeping that know-how secret, an
enterprise controls the benefits that are expected to flow from it.

57. The assets of an enterprise result from past transactions or other past
events. Enterprises normally obtain assets by purchasing or producing them, but

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Framework for the Preparation and Presentation of Financial Statements

other transactions or events may also generate assets; examples include land
received by an enterprise from government as part of a programme to encourage
economic growth in an area and the discovery of mineral deposits. Transactions
or other events expected to occur in the future do not in themselves give rise to
assets; hence, for example, an intention to purchase inventory does not, of itself,
meet the definition of an asset.

58. There is a close association between incurring expenditure and obtaining
assets but the two do not necessarily coincide. Hence, when an enterprise incurs
expenditure, this may provide evidence that future economic benefits were
sought but is not conclusive proof that an item satisfying the definition of an asset
has been obtained. Similarly, the absence of a related expenditure does not
preclude an item from satisfying the definition of an asset and thus becoming a
candidate for recognition in the balance sheet.

Liabilities

59. An essential 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. This is normally the case, for example, with
amounts payable for goods and services received. Obligations also arise,
however, from normal business practice, custom and a 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.

60. 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.

61. 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:

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Framework for the Preparation and Presentation of Financial Statements

(a) payment of cash;

(b) transfer of other assets;

(d) replacement of that obligation with another obligation; or

(e) conversion of the obligation to equity.

An obligation may also be extinguished by other means, such as a creditor
waiving or forfeiting its rights.

62. 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
loan 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 gives rise to the
liability.

63. 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.

Equity

64. Although equity is defined in paragraph 49 as a residual, it may be sub-
classified in the balance sheet. For example, funds contributed by owners,
reserves representing appropriations of retained earnings, unappropriated
retained earnings and reserves representing capital maintenance adjustments
may be shown separately. Such classifications can be relevant to the decision-
making needs of the users of financial statements when they indicate legal or
other restrictions on the ability of the enterprise to distribute or otherwise apply its
equity. They may also reflect the fact that parties with ownership interests in an
enterprise have differing rights in relation to the receipt of dividends or the
repayment of capital.

65. The creation of reserves is sometimes required by law in order to give the
enterprise and its creditors an added measure of protection from the effects of

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Framework for the Preparation and Presentation of Financial Statements

losses. Reserves may also be created when tax laws grant exemptions from, or
reductions in, taxation liabilities if transfers to such reserves are made. The
existence and size of such reserves is information that can be relevant to the
decision-making needs of users. Transfers to such reserves are appropriations of
retained earnings rather than expenses.

66. The amount at which equity is shown in the balance sheet is dependent on
the measurement of assets and liabilities. Normally, the aggregate amount of
equity only by coincidence corresponds with the aggregate market value of the
shares of the enterprise or the sum that could be raised by disposing of either the
net assets on a piecemeal basis or the enterprise as a whole on a going concern
basis.

67. Commercial, industrial and business activities are often undertaken by
means of enterprises such as sole proprietorships, partnerships and trusts and
various types of government business undertakings. The legal and regulatory
framework for such enterprises is often different from that applicable to corporate
enterprises. For example, unlike corporate enterprises, in the case of such
enterprises, there may be few, if any, restrictions on the distribution to owners or
other beneficiaries of amounts included in equity. Nevertheless, the definition of
equity and the other aspects of this Framework that deal with equity are
appropriate for such enterprises.

Performance

68. Profit is frequently used as a measure of performance or as the basis for
other measures, such as return on investment or earnings per share. The
elements directly related to the measurement of profit are income and expenses.
The recognition and measurement of income and expenses, and hence profit,
depends in part on the concepts of capital and capital maintenance used by the
enterprise in preparing its financial statements. These concepts are discussed in
paragraphs 101 to 109.

69. Income and expenses are defined as follows:

(a) Income is increase in economic benefits during the accounting period
in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those relating to
contributions from equity participants.

(b) Expenses are decreases in economic benefits during the accounting
period in the form of outflows or depletions of assets or incurrences

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Framework for the Preparation and Presentation of Financial Statements

of liabilities that result in decreases in equity, other than those
relating to distributions to equity participants.

70. The definitions of income and expenses identify their essential features but
do not attempt to specify the criteria that need to be met before they are
recognised in the statement of profit and loss. Criteria for recognition of income
and expenses are discussed in paragraphs 81 to 97.

71. Income and expenses may be presented in the statement of profit and loss
in different ways so as to provide information that is relevant for economic
decision-making. For example, it is a common practice to distinguish between
those items of income and expenses that arise in the course of the ordinary
activities of the enterprise and those that do not. This distinction is made on the
basis that the source of an item is relevant in evaluating the ability of the
enterprise to generate cash and cash equivalents in the future. When
distinguishing between items in this way, consideration needs to be given to the
nature of the enterprise and its operations. Items that arise from the ordinary
activities of one enterprise may be extraordinary in respect of another.

72. Distinguishing between items of income and expense and combining them
in different ways also permits several measures of enterprise performance to be
displayed. These have differing degrees of inclusiveness. For example, the
statement of profit and loss could display gross margin, profit from ordinary
activities before taxation, profit from ordinary activities after taxation, and net
profit.

Income

73. The definition of income encompasses both revenue and gains. Revenue
arises in the course of the ordinary activities of an enterprise and is referred to by
a variety of different names including sales, fees, interest, dividends, royalties
and rent.

74. Gains represent other items that meet the definition of income and may, or
may not, arise in the course of the ordinary activities of an enterprise. Gains
represent increases in economic benefits and as such are no different in nature
from revenue. Hence, they are not regarded as a separate element in this
Framework.
75. The definition of income includes unrealised gains. Gains also include, for
example, those arising on the disposal of fixed assets. When gains are
recognised in the statement of profit and loss, they are usually displayed
separately because knowledge of them is useful for the purpose of making

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Framework for the Preparation and Presentation of Financial Statements

economic decisions.

76. Various kinds of assets may be received or enhanced by income; examples
include cash, receivables and goods and services received in exchange for
goods and services supplied. Income may also result in the settlement of
liabilities. For example, an enterprise may provide goods and services to a lender
in settlement of an obligation to repay an outstanding loan.

Expenses

77. The definition of expenses encompasses those expenses that arise in the
course of the ordinary activities of the enterprise, as well as losses. Expenses
that arise in the course of the ordinary activities of the enterprise include, for
example, cost of goods sold, wages, and depreciation. They take the form of an
outflow or depletion of assets or enhancement of liabilities.

78. Losses represent other items that meet the definition of expenses and may,
or may not, arise in the course of the ordinary activities of the enterprise. Losses
represent decreases in economic benefits and as such they are no different in
nature from other expenses. Hence, they are not regarded as a separate
element in this Framework.

79. Losses include, for example, those resulting from disasters such as fire and
flood, as well as those arising on the disposal of fixed assets. The definition of
expenses also includes unrealised losses. When losses are recognised in the
statement of profit and loss, they are usually displayed separately because
knowledge of them is useful for the purpose of making economic decisions.

Capital Maintenance Adjustments

80. The revaluation or restatement of assets and liabilities gives rise to
increases or decreases in equity. While these increases or decreases meet the
definition of income and expenses, they are not included in the statement of
profit and loss under certain concepts of capital maintenance. Instead, these
items are included in equity as capital maintenance adjustments or revaluation
reserves. These concepts of capital maintenance are discussed in paragraphs
101 to 109 of this Framework.

Recognition of the Elements of Financial Statements
81. Recognition is the process of incorporating in the balance sheet or
statement of profit and loss an item that meets the definition of an element and

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Framework for the Preparation and Presentation of Financial Statements

satisfies the criteria for recognition set out in paragraph 82. It involves the
depiction of the item in words and by a monetary amount and the inclusion of
that amount in the totals of balance sheet or statement of profit and loss. Items
that satisfy the recognition criteria should be recognised in the balance sheet or
statement of profit and loss. The failure to recognise such items is not rectified by
disclosure of the accounting policies used nor by notes or explanatory material.

82. An item that meets the definition of an element should be recognised if:

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

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

83. In assessing whether an item meets these criteria and therefore qualifies
for recognition in the financial statements, regard needs to be given to the
materiality considerations discussed in paragraph 30. The interrelationship
between the elements means that an item that meets the definition and
recognition criteria for a particular element, for example, an asset, automatically
requires the recognition of another element, for example, income or a liability.

The Probability of Future Economic Benefits

84. The concept of probability is used in the recognition criteria to refer to the
degree of uncertainty that the future economic benefits associated with the item
will flow to or from the enterprise. The concept is in keeping with the uncertainty
that characterises the environment in which an enterprise operates.
Assessments of the degree of uncertainty attaching to the flow of future
economic benefits are made on the basis of the evidence available when the
financial statements are prepared. For example, when it is probable that a
receivable will be realised, it is then justifiable, in the absence of any evidence to
the contrary, to recognise the receivable as an asset. For a large population of
receivables, however, some degree of non-payment is normally considered
probable; hence, an expense representing the expected reduction in economic
benefits is recognised.

Reliability of Measurement

85. The second criterion for the recognition of an item is that it possesses a
cost or value that can be measured with reliability as discussed in paragraphs 31
to 38 of this Framework. In many cases, cost or value must be estimated; the
use of reasonable estimates is an essential part of the preparation of financial

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Framework for the Preparation and Presentation of Financial Statements

statements and does not undermine their reliability. When, however, a
reasonable estimate cannot be made, the item is not recognised in the balance
sheet or statement of profit and loss. For example, the damages payable in a
lawsuit may meet the definitions of both a liability and an expense as well as the
probability criterion for recognition; however, if it is not possible to measure the
claim reliably, it should not be recognised as a liability or as an expense.

86. An item that, at a particular point in time, fails to meet the recognition
criteria in paragraph 82 may qualify for recognition at a later date as a result of
subsequent circumstances or events.

87. An item that possesses the essential characteristics of an element but fails
to meet the criteria for recognition may nonetheless warrant disclosure in the
notes, explanatory material or supplementary schedules. This is appropriate
when knowledge of the item is considered to be relevant to the evaluation of the
financial position, performance and cash flows of an enterprise by the users of
financial statements. Thus, in the example given in paragraph 85, the existence
of the claim would need to be disclosed in the notes, explanatory material or
supplementary schedules.

Recognition of Assets

88. An asset is recognised in the balance sheet when it is probable that the
future economic benefits associated with it will flow to the enterprise and the
asset has a cost or value that can be measured reliably.

89. An asset is not recognised in the balance sheet when expenditure has been
incurred for which it is considered improbable that economic benefits will flow to
the enterprise beyond the current accounting period. Instead, such a transaction
results in the recognition of an expense in the statement of profit and loss. This
treatment does not imply either that the intention of management in incurring
expenditure was other than to generate future economic benefits for the
enterprise or that management was misguided. The only implication is that the
degree of certainty that economic benefits will flow to the enterprise beyond the
current accounting period is insufficient to warrant the recognition of an asset.

Recognition of Liabilities

90. A liability is recognised in the balance sheet when it is probable that an
outflow of resources embodying economic benefits will result from the settlement
of a present obligation and the amount at which the settlement will take place
can be measured reliably. In practice, obligations under contracts that are

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Framework for the Preparation and Presentation of Financial Statements

equally proportionately unperformed (for example, liabilities for inventory ordered
but not yet received) are generally not recognised as liabilities in the financial
statements. However, such obligations may meet the definition of liabilities and,
provided the recognition criteria are met in the particular circumstances, may
qualify for recognition. In such circumstances, recognition of liabilities entails
recognition of related assets or expenses.

Recognition of Income

91. Income is recognised in the statement of profit and loss 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).

92. The procedures normally adopted in practice for recognising income, for
example, the requirement that revenue should be earned, are applications of the
recognition criteria in this Framework. Such procedures are generally directed at
restricting the recognition as income to those items that can be measured reliably
and have a sufficient degree of certainty.

Recognition of Expenses

93. Expenses are recognised in the statement of profit and loss when a
decrease in 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 increase of liabilities or a decrease in assets (for example, the accrual of
employees’ salaries or the depreciation of plant and machinery).

94. Many expenses are recognised in the statement of profit and loss on the
basis of a direct association between the costs incurred and the earning of
specific items of income. This process, commonly referred to as the matching of
costs with revenues, involves the simultaneous or combined recognition of
revenues and expenses that result directly and jointly from the same transactions
or other events; for example, the various components of expense making up the
cost of goods sold are recognised at the same time as the income derived from
the sale of the goods. However, the application of the matching concept under
this Framework does not allow the recognition of items in the balance sheet
which do not meet the definition of assets or liabilities.

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Framework for the Preparation and Presentation of Financial Statements

95. 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 recognised in the statement of profit and loss on the
basis of systematic and rational allocation procedures. This is often necessary in
recognising the expenses associated with the using up of assets such as plant
and machinery, goodwill, patents and trademarks; in such cases, the expense is
referred to as depreciation or amortisation. These allocation procedures are
intended to recognise expenses in the accounting periods in which the economic
benefits associated with these items are consumed or expire.

96. An expense is recognised immediately in the statement of profit and loss
when an expenditure produces no future economic benefits. An expense is also
recognised to the extent that future economic benefits from an expenditure do
not qualify, or cease to qualify, for recognition in the balance sheet as an asset.

97. An expense is recognised in the statement of profit and loss in those cases
also where a liability is incurred without the recognition of an asset, for example,
in the case of a liability under a product warranty.

Measurement of the Elements of Financial Statements
98. Measurement is the process of determining the monetary amounts at which
the elements of financial statements are to be recognised and carried in the
balance sheet and statement of profit and loss. This involves the selection of the
particular basis of measurement.

99. A number of different measurement bases are employed to different
degrees and in varying combinations in financial statements. They include the
following:

(a) Historical cost. Assets are recorded at the amount of cash or cash
equivalents paid or the fair value of the other consideration given to
acquire them at the time of their acquisition. Liabilities are recorded
at the amount of proceeds received in exchange for the obligation, or
in some circumstances (for example, income taxes), at the amounts
of cash or cash equivalents expected to be paid to satisfy the liability
in the normal course of business.

(b) 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 were acquired currently. Liabilities are carried at the

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Framework for the Preparation and Presentation of Financial Statements

undiscounted amount of cash or cash equivalents that would be
required to settle the obligation currently.

(c) Realisable (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 required to settle the liabilities in the
normal course of business.

(d) Present value. Assets are carried at the present value of the future
net cash inflows that the item is expected to generate in the normal
course of business. Liabilities are carried at the present value of the
future net cash outflows that are expected to be required to settle the
liabilities in the normal course of business.

100. The measurement basis most commonly adopted by enterprises in
preparing their financial statements is historical cost. This is usually combined
with other measurement bases. For example, inventories are usually carried at
the lower of cost and net realisable value and pension liabilities are carried at
their present value. Furthermore, the current cost basis may be used as a
response to the inability of the historical cost accounting model to deal with the
effects of changing prices of non-monetary assets.

Concepts of Capital and Capital Maintenance
Concepts of Capital

101. Under a financial concept of capital, such as invested money or invested
purchasing power, capital is synonymous with the net assets or equity of the
enterprise. Under a physical concept of capital, such as operating capability,
capital is regarded as the productive capacity of the enterprise based on, for
example, units of output per day.

102. The selection of the appropriate concept of capital by an enterprise should
be based on the needs of the users of its financial statements. Thus, a financial
concept of capital should be adopted if the users of financial statements are
primarily concerned with the maintenance of nominal invested capital or the
purchasing power of invested capital. If, however, the main concern of users is
with the operating capability of the enterprise, a physical concept of capital
should be used. The concept chosen indicates the goal to be attained in
determining profit, even though there may be some measurement difficulties in

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Framework for the Preparation and Presentation of Financial Statements

making the concept operational.

Concepts of Capital Maintenance and the Determination of Profit

103. The concepts of capital described in paragraph 101 give rise to the
following concepts of capital maintenance:

(a) Financial capital maintenance. Under this concept, a profit is earned
only if the financial (or money) amount of the net assets at the end of
the period exceeds the financial (or money) amount of net assets at
the beginning of the period, after excluding any distributions to, and
contributions from, owners during the period. Financial capital
maintenance can be measured in either nominal monetary units or
units of constant purchasing power.

(b) Physical capital maintenance. Under this concept, a profit is earned
only if the physical productive capacity (or operating capability) of the
enterprise at the end of the period exceeds the physical productive
capacity at the beginning of the period, after excluding any
distributions to, and contributions from, owners during the period.

104. The concept of capital maintenance is concerned with how an enterprise
defines the capital that it seeks to maintain. It provides the linkage between the
concepts of capital and the concepts of profit because it provides the point of
reference by which profit is measured; it is a prerequisite for distinguishing
between an enterprise's return on capital and its return of capital; only inflows of
assets in excess of amounts needed to maintain capital can be regarded as profit
and therefore as a return on capital. Hence, profit is the residual amount that
remains after expenses (including capital maintenance adjustments, where
appropriate) have been deducted from income. If expenses exceed income, the
residual amount is a net loss.
105. The physical capital maintenance concept requires the adoption of the
current cost basis of measurement. The financial capital maintenance concept,
however, does not require the use of a particular basis of measurement.
Selection of the basis under this concept is dependent on the type of financial
capital that the enterprise is seeking to maintain.

106. The principal difference between the two concepts of capital maintenance is
the treatment of the effects of changes in the prices of assets and liabilities of the
enterprise. In general terms, an enterprise has maintained its capital if it has as
much capital at the end of the period as it had at the beginning of the period. Any
amount over and above that required to maintain the capital at the beginning of

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Framework for the Preparation and Presentation of Financial Statements

the period is profit.

107. Under the concept of financial capital maintenance where capital is defined
in terms of nominal monetary units, profit represents the increase in nominal
money capital over the period. Thus, increases in the prices of assets held over
the period, conventionally referred to as holding gains, are, conceptually, profits.
They may not be recognised as such, however, until the assets are disposed of
in an exchange transaction. When the concept of financial capital maintenance is
defined in terms of constant purchasing power units, profit represents the
increase in invested purchasing power over the period. Thus, only that part of the
increase in the prices of assets that exceeds the increase in the general level of
prices is regarded as profit. The rest of the increase is treated as a capital
maintenance adjustment and, hence, as part of equity.

108. Under the concept of physical capital maintenance when capital is defined
in terms of the physical productive capacity, profit represents the increase in that
capital over the period. All price changes affecting the assets and liabilities of the
enterprise are viewed as changes in the measurement of the physical productive
capacity of the enterprise; hence, they are treated as capital maintenance
adjustments that are part of equity and not as profit.

109. The selection of the measurement bases and concept of capital
maintenance will determine the accounting model used in the preparation of the
financial statements. Different accounting models exhibit different degrees of
relevance and reliability and, as in other areas, management must seek a
balance between relevance and reliability. This Framework is applicable to a
range of accounting models and provides guidance on preparing and presenting
the financial statements under the chosen model.