To be recognized, an item must meet the definition of an element provided in the conceptual framework, and satisfy the following criteria:
- It is probable that any future economic benefit associated with the item will flow to or from the entity; and
- The item’s cost or value can be measured with reliability.
The general criteria for recognizing elements in financial statements is provided below:
- Assets: An asset is recognized in the balance sheet when it is probable that the future economic benefits will flow to the entity and the asset has a cost or value that can be measured reliably. The economic benefits contribute, directly or indirectly, in the form of cash or cash equivalents. Even though many assets are in physical form, such as machinery, the physical form is not essentials. For example, patents and intellectual property are assets controlled by the entity and have future economic benefits.
- Liabilities: A liability is recognized 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. For example, accounts payables are present obligations, which will result in an outflow of resources embodying economic benefits.
- 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. In effect, the recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities. For example, when a sale is made, it results in a net increase in assets (cash). Income includes both revenues and gains, such as from sale of assets that are not a part of the normal business activity.
- Expenses: Expenses are recognized 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. In effect, the recognition of expenses occurs simultaneously with the recognition of an increase in liabilities or a decrease in assets. For example, the depreciation of an asset decreases the asset and the expense is recognized. Expenses include both expenses and losses.