Question

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Case #2

Financial Reporting and Uncertainty

Textbooks tend to rely on clear and unambiguous cases. However, in practice, recording
transactions in the accounting system requires application of defined characteristics of the
elements of financial statements to unusual or uncertain situations. Practitioners must
understand the inherent uncertainty in accounting measures and distinctions between closely
related accounting concepts when evaluating the effects of transactions on the financial
statements.
Required (4 points):
The left hand menu on the FASC site contains a link to the Conceptual Framework. Follow
that link and access Concept #6 Elements of the Financial Statements to answer the
following items. For each of the four items below, be sure to identify the paragraph(s)
you are referencing (e.g., ‘CON6 Par12.’).
(1) What are the three essential characteristics of assets?
(2) What are the three essential characteristics of liabilities?
(3) Paraphrase the paragraph(s) discussing uncertainty and its effect on financial
statements.
(4)  Paraphrase the paragraph(s) discussing the difference between realization and
recognition.

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Answer 1

ANSWER-

(1) The three essential characteristics of assets are of the following- (CON6- 12, Par 26)

(a) It engulfs the benefits that an investor is likely to get in future, either it will solely contribute towards it or along with another kind of asset, in the form of cash inflows.

(b) A single entity can take the advantage of it and manipulate others' access to it it as well.

(c) All the transactions, related to that asset, belong to the entity which is holding the same.

(2) The three essential characteristics of liabilities are of the following- (CON6- 13, Par 36)

(a) It engulfs the responsibility, towards the third party or any other entity, to pay a stipulated amount in terms of cash, asset or any other negotiable instrument, as per the consent of both parties involved.

(b) The responsibility on a particular entity or on a party can neither be reversed nor avoided in future, in any circumstances.

(c) The transaction, due to which the obligation or responsibility is created on the party to pay in future, has already completed.

(3) Paraphrasing of uncertainty and its impact on financial statements- (CON6- 15, Par 46 to 48)

Uncertainty is ubiquitous. The business facing uncertainties, leads to the difficulty of assessment of assets and liabilities. This difficulty leads to incorrect recognition of items with respect to their main heads like 'Revenues', 'Expenses', 'Assets' and 'Liabilities', which makes an erroneous data. The unrecognised items or erroneous recognition of items shows that they are not worth anybody's time and efforts as well as the inefficiency of a 'Cost and Benefit' analysis done before. After delving into such situations, it was found that the amount of items does not need to be certain for their entries under correct heads and their future estimates will more often than not be required. The assessment of probability is somewhat required, to distinguish between assets and liabilities, rather than it's degree. Some elements which are part of the definitions of assets/liabilities, have to ignored to carry out measurement, uncertainty or unreliability. Similarly, some elements are there which are required in uncertainties but are not part of definitions of assets and liabilities.

(4) Paraphrasing of Difference Between Realization and Recognition- (CON6- 34, 143)

Realization is the term used to define a process through which revenues are realized from anything that are converted into cash or cash equivalents. Two terms are used in this respect viz., Realized (which results into ultimate profits) and Unrealized (which results into losses). Recognition refers to a process wherein an item is recognised in terms of its nature and definitions, in order to record it in financial statements of an entity. Two terms are used in this respect viz., Recognised (which have been recorded in the financial statements) and Unrecognised (which have not been recorded in financial statements)