Project Update

Conceptual Framework—Phase B: Elements and Recognition

Latest revisions: As of 29, July 2008 (Updated sections are indicated with an asterisk *)

This project update summarizes the project activities and decisions of the IASB and FASB (the Boards). It was prepared by the staff and is for the information and convenience of the Boards’ constituents. All decisions of the Boards are tentative, may change at future Board meetings, and do not change current accounting and reporting requirements. Decisions of the Boards become final only after extensive due process.

Project Objective
*Decisions Reached at the Last Meeting
*Summary of Decisions Reached to Date
*Next Steps
Board/Other Public Meetings
Background Information
Contact Information

Phase B Objectives

The objectives of Phase B, Elements and Recognition, are to refine and converge the Boards’ frameworks as follows:

Revise and clarify the definitions of asset and liability.
Resolve differences regarding other elements and their definitions.
Revise the recognition criteria concepts to eliminate differences and provide a basis for resolving issues such as derecognition and unit of account.

*Decisions Reached at the Last Meeting

IASB Update June 2008
FASB Action Alert—June 25, 2008 meeting

*Summary of Decisions Reached to Date

Asset Definition

The Boards agreed that the current frameworks’ existing asset definitions have the following shortcomings:

Some users misinterpret the terms “expected” (IASB definition) and “probable” (FASB definition) to mean that there must be a high likelihood of future economic benefits for the definition to be met; this excludes asset items with a low likelihood of future economic benefits.
The definitions place too much emphasis on identifying the future flow of economic benefits, instead of focusing on the item that presently exists, an economic resource.
Some users misinterpret the term “control” and use it in the same sense as that used for purposes of consolidation accounting. The term should focus on whether the entity has some rights or privileged access to the economic resource.
The definitions place undue emphasis on identifying the past transactions or events that gave rise to the asset, instead of focusing on whether the entity had access to the economic resource at the balance sheet date.

After consulting technical experts, the Boards decided to consider the following working definition of an asset:

An asset of an entity is a present economic resource to which, through an enforceable right or other means, the entity has access or can limit the access of others.

Accompanying text will amplify the asset definition by describing present, economic resource, enforceable right, and other means:

Present means that both the economic resource and the enforceable right or other means by which the entity has access or can limit the access of others exist on the date of the financial statements.
An economic resource is something that is scarce and capable of producing cash inflows or reducing cash outflows, directly or indirectly, alone or together with other economic resources.
An enforceable right is legally enforceable or enforceable by equivalent means (such as by a professional association), and it enables the entity to use the present economic resource directly or indirectly and precludes or limits its use by others.

Liability Definition

The Boards agreed that the current frameworks’ existing liability definitions have the following shortcomings:

Some users misinterpret the terms “expected” (IASB definition) and “probable” (FASB definition) to mean that there must be a high likelihood of future outflow of economic benefits for the definition to be met; this excludes liability items with a low likelihood of a future outflow of economic benefits.
The definitions place too much emphasis on identifying the future outflow of economic benefits, instead of focusing on the item that presently exists, an economic obligation.
The definitions place undue emphasis on identifying the past transactions or events that gave rise to the liability, instead of focusing on whether the entity has an economic obligation at the balance sheet date.
It is unclear how the definition applies to contractual obligations.

The Boards considered the following working definition of a liability:

A liability of an entity is a present economic obligation that is enforceable against the entity.

Accompanying text will amplify the liability definition by describing present, economic obligation, and enforceable:

Present means that the economic obligation exists on the date of the financial statements.
An economic obligation is something that is capable of resulting in cash outflows or reduced cash inflows, directly or indirectly, alone or together with other economic obligations.
Obligations link the entity with what it has to do because obligations are enforceable against the entity by legal or equivalent means.

The Boards agreed that the existence of a present obligation distinguishes a liability from a general risk. A present economic obligation conceptually exists when an entity is committed to a particular action(s) that is capable of resulting in cash flows and there is a mechanism to enforce that economic obligation against the entity. The Board also agreed that laws and regulations are examples of mechanisms and are not, by themselves, present obligations.

The FASB suggested testing the working definition of a liability against examples that have characteristics of both liabilities and equity to help ensure that the conceptual definitions being developed will be compatible with the proposals in the FASB’s recently released Preliminary Views on Financial Instruments with the Characteristics of Equity. The IASB also discussed whether to modify its approach to developing a definition of a liability to more closely align that definition with alternatives being considered in its research project on liabilities and equity.

The Boards directed the staff to consider revising the working definition of a liability to (1) include an additional reference that an economic obligation must be unconditional and (2) replace the description that an economic obligation is something that is capable of resulting in “cash outflows or reduced cash inflows, directly or indirectly” with “provision of an economic resource.”

Stand Ready Obligations

The Boards agreed that it is helpful to analyze contracts and other binding agreements to identity whether they contain unconditional and conditional obligations. An unconditional obligation requires performance to occur now or over a period of time, whereas a conditional obligation requires performance to occur if an uncertain future event occurs. In situations where a conditional obligation is identified, it can be helpful to assess if there is an accompanying unconditional obligation that presently requires the entity to perform. The Board also agreed that noncontractual scenarios can be analyzed to identify unconditional and conditional obligations.

Statutes, Laws, and Regulations

The Board noted that an entity may be subject to the requirements of a statute, law, or regulation, yet a government or other party cannot enforce those requirements until the entity violates the statute, law, or regulation or until an event occurs that triggers the requirements. The Boards decided the following:

An entity does not have a present unconditional obligation
1. To comply with a statute that is not yet effective,
2. For future actions it expects or intends to take but cannot be compelled to take, and
3. To transfer economic resources merely because it must comply with the law. An obligating event must also have occurred.
An entity has a present unconditional obligation
1. At the reporting date when the entity violates a requirement or when another obligating event has occurred,
2. That has an associated conditional obligation (a stand-ready obligation) when a statute requires the entity to provide risk protection. That requirement results in an implicit contractual obligation between the two parties, and
3. That has an associated conditional obligation when the entity separately agrees to bear another’s risk that arises from being subject to a statute.

Dealing with Uncertainties

Uncertainties result from situations where evidence is lacking or facts are unclear. The Board considered whether to address uncertainties about whether a liability exists in the guidance accompanying the definition or in the criteria for recognition. The Boards decided to address uncertainty in the guidance accompanying the definitions of an asset and a liability. If an entity is uncertain about whether a liability exists, that entity should make a neutral judgment based on its understanding of the facts and circumstances at the end of the reporting period. If it is judged that a liability exists, uncertainty about the amount of the liability would be taken into account in measurement. The Boards also decided that additional guidance should be developed on how those judgments can be made in a comparable manner at a standards level.

*Next Steps

The staff has commenced drafting the sections pertaining to the definitions of an asset and a liability in a forthcoming discussion paper. As well, the staff plans to begin discussions with the Boards on three areas that have not previously been addressed:

Other Elements

The FASB Concepts Statements presently identify more elements than does the IASB Framework, and the two frameworks define differently those elements that are common. The Boards’ approach will focus initially on converging and defining only those key elements that are defined today in the IASB and FASB Frameworks. As well, the Boards will need to consider the extent to which, and if so how, to define elements that are not defined today, such as comprehensive income.
Unit of Account

The Boards' current frameworks provide little or no guidance on how the unit of account should be determined. Discussions of various standard projects have raised the following issues regarding the identification of the appropriate unit of account:
1. Should similar things be accounted for together (rather than separately)?
2. Should an entity recognize assets and/or liabilities for contracts that are still fully executory? If so, which assets and liabilities should it recognize, and should the entity account for and report them separately or as a single net item?
3. Should some "related" assets and liabilities be accounted for together or netted?
In this part of Phase B, the Boards intend to develop guidance to assist in analyzing such issues.
Recognition and Derecognition

Each Board’s current framework describes specific recognition criteria, some of which are similar and some of which are different. Neither Board's frameworks contain criteria as to when an item should be derecognized. The Boards plan to revise their recognition criteria concepts to eliminate those differences and provide a framework for resolving derecognition issues.

Board/Other Public Meetings

View the FASB and IASB meeting handouts, minutes, and updates.

Background Information

The Boards expect that their joint conceptual framework project will benefit from their standard-setting projects and research being conducted by others on behalf of the Boards. Activities related to elements and recognition include the following:

Revenue Recognition

The joint FASB and IASB Revenue Recognition project is developing guidance for revenue recognition.

FASB Revenue Recognition Project
IASB—Liabilities and Revenue Recognition.

Liabilities and Equity

The Liabilities and Equity project is considering improvements to the definitions of liabilities, equity, and assets. The FASB issued Preliminary Views (PV), Financial Instruments with Characteristics of Equity and IASB issued Discussion Paper, Financial Instruments with Characteristics of Equity—Invitation to Comment, based on the FASB PV. The FASB and IASB plan to use the input received on these documents as the basis for a joint project to develop a high-quality standard.

FASB Liabilities and Equity Project
IASB Liabilities and Equity Project
Preliminary Views, Financial Instruments with Characteristics of Equity

Contact Information

Ian Hague
Principal, Canadian Accounting Standards Board
ian.hague@cica.ca

Rebecca Villmann
Principal, Canadian Accounting Standards Board
rebecca.villmann@cica.ca

Mark Bunting
IASB Project Manager
mbunting@iasb.org