Module: 03.

Recognition, Measurement and Disclosure of Elements of Income

Statement:
Income statement:
(also referred to as profit and loss statement (P&L), statement of financial performance,
earnings statement, operating statement or statement of operations) is a company's financial
statement that indicates how the revenue (money received from the sale of products and services
before expenses are taken out, also known as the "top line") is transformed into the net income
(the result after all revenues and expenses have been accounted for, also known as the "bottom
line"). It displays the revenues recognized for a specific period, and the cost and expenses
charged against these revenues, including write-offs (e.g., depreciation and amortization of
various assets) and taxes. The purpose of the income statement is to show managers and
investors whether the company made or lost money during the period being reported.
Usefulness and limitations of income statement:
Income statements should help investors and creditors determine the past financial
performance of the enterprise, predict future performance, and assess the capability of generating
future cash flows through report of the income and expenses.
However, information of an income statement has several limitations:
1. Items that might be relevant but cannot be reliably measured are not reported (e.g. brand
recognition and loyalty).
2. Some numbers depend on accounting methods used (e.g. using FIFO or LIFO accounting
to measure inventory level).
3. Some numbers depend on judgments and estimates (e.g. depreciation expense depends on
estimated useful life and salvage value).
Elements of Income statement:
Revenue
Expenses.
Recognition: An item is recognized in the financial statements when:
it is probable future economic benefit will flow to or from an entity.
the resource can be reliably measured
Measurement: According to the Framework of IAS, the term 'measurement' has been defined in
the following words: process of determining the monetary amounts at which the elements of
the financial statements are to be recognized and carried in the balance sheet and income
statement.
Measurement of the Elements of Financial Statements:
There are a number of measurement basis that are employed in different degrees and in varying
combinations in financial statements. They are listed below:
1. Historical cost: Historical cost is the most common measurement basis adopted by
enterprises in preparing their financial statements. This is usually combined with other
measurement basis, such as current cost basis, realizable basis, etc., which are discussed
later in this section. Under historical cost measurement basis, assets are originally

recorded at their costs or purchasing price or the fair value of the consideration given to
acquire them at the time of their acquisition. Liabilities are recorded at the amount of
proceeds received received in exchange for the obligation.
2. Current cost: Under current cost basis, assets are carried at the amount of cash that
would have to be paid if the same or an equivalent asset was acquired currently.
Liabilities are carried at the undiscounted amount of cash that would be required to settle
the obligations currently.
3. Realizable value: Assets are carried at the amount of cash that could currently be
obtained by selling the asset in an orderly disposal. Liabilities are carried at their
settlement values; that is, the undiscounted amount of cash expected to be paid or satisfy
the liabilities in the normal course of business.
4. Present value: Assets are carried at the present discounted 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 presented discounted value of the future net cash outflows that are
expected to be required to settle the liabilities in the normal course of business.

Revenues:
Income determination in accounting is the process of identifying, measuring and relating
revenues and expenses of a business enterprise for a accounting period. Revenues are inflows or
other enhancements of assets of an enterprise or settlements of its liabilities (or a combination of
both) during a period from delivering or producing goods, rendering services, or other activities
that constitute the enterprises ongoing major or central operations. Accounting Principles Board
of U.S.A. has given the following definition of revenue:
Revenue is gross increase in assets or gross decrease in assets or gross decrease in
liabilities recognized and measured in conformity with generally accepted accounting principles
that results from those types of profit - directed activities of an enterprise that can change
owners equity.
The Accounting Standards Board of the Institute of Chartered Accountants of India
defines revenue in the following manner: Revenue is the gross inflow of cash, receivables or
other consideration arising in the course of the ordinary activities of an enterprise from the sale
of goods, from the rendering of services, and from the use by other of enterprise resources
yielding interest, royalties and dividends. Revenue is measured by the charges made to customers
or clients for goods supplied and services rendered to them and by the charges and rewards
arising from the use of resources by them. In an agency relationship, the revenue is the amount
of commission and not the gross inflow of cash, receivables or other consideration.
Under Generally Accepted Accounting Principles, the following receipts of the proceeds
are not recognized as revenues:
1. Realized gains resulting from the disposal of, and unrealized gains resulting from the
holding of non-current assets e.g. fixed assets;
2. Unrealized holding gains resulting from the change in value of current assets, and the
natural increase in herds and agricultural and forest products;
3. Realized or unrealized gains resulting from changes in foreign exchange rates and
adjustments arising on the translation of foreign currency financial statements;

4. Realized gains resulting from the discharge of an obligation at less than its carrying
amount.
5. Unrealized gains resulting from the restatement of the carrying amount of an obligation.
Thus, revenue does not include all recognized increases in assets or decreases in liabilities.
Receipts of the proceeds of a cash sale is revenue under present generally accepted accounting
principles because the net result of the sale is a change in owners equity. On the other hand,
receipts of proceeds of a loan, investment by owners, or receipt of an asset purchased for cash
are not revenue under present generally accepted accounting principles because owners equity
cannot change at the time of the loan or purchase.
Revenue Related Activities
Revenue recognition is mainly concerned with the timing of recognition of revenue in the
income statement of an enterprise. Before explaining the revenue recognition criteria, it may be
appropriate to understand the operating cycle of a business enterprise, especially in a
manufacturing concern. The following six critical events are generally found in the operating
cycle of a manufacturing company.
(1) Acquisition of resources
(2) Receipts of customer orders
(3) Production
(4) Delivery of goods or performance of services
(5) Collection of cash
(6) Completion of all contractual obligations
It may be mentioned that each of the above critical events is a productive activity that adds value
in some measure to the goods or merchandise purchased. On these grounds, a portion of the
ultimate sale price ought to be recognised as revenue as each activity is performed. The difficulty
is that ultimate sale price is the joint product of all activities, and it is impossible to say with
certainty how much is attributable to any one of them. For this reason, accounting select one
event as the signal for revenue and expense recognition the others.
Revenues, in most cases are the joint result of many profit-directed activities (events) of
an enterprise and revenue is often described as being earned gradually and continuously by the
whole of enterprise activities. Earnings in this sense is a technical term that refers to the activities
that gave rise to the revenue- purchasing, manufacturing, rendering service, delivering goods, the
occurrence of an event specified in a contract and so forth. All of the profit-directed activities of
an enterprise that comprise the process by which revenue is earned is, therefore, rightly called
the earning process.
Revenue Recognition Criteria
Revenue may be described as being earned gradually and continuously, it may be recognised at a
number of points during the production and sales of a product. The revenue recognition rules can
be studied properly while describing the following activities:
1. Sale of Goods
2. Rendering of Services
3. Use by others of enterprise resources yielding interest, royalties, fees and dividends
4. Installment method

5. Money received or amounts paid in advance

1. Sale of Goods
A key criterion for determining when to recognize revenue from a transaction involving
the sale of goods is that the seller has transferred the property in the goods to the buyer for a
price. The transfer of property in goods, in most cases, results in or coincides with the transfer of
significant risks and rewards of ownership to the buyer, there may be situations where transfer of
property in goods does not coincide with the transfer of significant risks and rewards of
ownership to the buyer. Such cases may arise where delivery has been delayed through the fault
of either the buyer or the seller and the goods are at the risk of the party at fault as regards any
loss which might not have occurred but for such fault. Further, sometimes the parties may agree
that the risk will pass at a time different form the time when ownership passes.
At certain stages in specific industries, such as when agricultural crops have been
harvested or mineral ores have been extracted, performance may be substantially complete prior
to the execution of the transaction generating revenue. In such cases when sale is assured under
forward contract or a government guarantee or where market exists and there is a negligible risk
of failure to sell, the goods involved are often valued at net realisable value. Such amounts while
not revenue are sometimes recognized in the statement of profit and loss and appropriately
described.
2. Rendering of services
Revenue from service transaction is usually recognised as the service is performed, either
by the proportionate completion method or by the completed service contract method:
(i) Proportionate or Percentage Completion method-This method has four basic characteristics:
(a) Costs are accumulated separately for each distinct work project, contract or job order;
each of these may be referred to as a job.
(b) The ratio of the amount of work done on each job to the total amount of work required by
that job is estimated at the end of each period.
(c) Revenue from each job is recognised in proportion on the job, as measured by the ratio of
the work done to total work required.
(d) Job costs are recognised as expenses as revenues are recognised.
The percentage- completion method is most often used when the production cycle is long, the
work is done under contracts with specific clients or customers, and adequate data on progress
are available. The contracts provide a basis on which to estimate the amount of cash to be
collected after all production work has been competed; if the progress percentage data are valid,
they provide assurance that the work done to date will ultimately lead to the collection of cash.
Since the cost of the work done to date is readily measurable, the revenue- recognition criteria
are satisfied at the time of production as long as reliable progress percentage data are available.
The percentage- completion method recognises net revenue (profit) prior to realization. It
is sanctioned in order to permit the reporting of profit on a yearly basis by those entities involved
in long- term construction projects. It is significant to note that the matching process normally
entails first identifying revenues of a given period and then matching certain costs against them
to obtain net income or profit. That is, revenues are identified as the independent variable and
costs, the dependent. But the percentage completion method reverses the procedure by

identifying the costs incurred in a given period as the independent variable and then matching
future revenue to them.
Income Effects of Percentage- Completion Method
Percentage- completion method has two effects. First, it leads to earlier recognition of
revenue. Investors and external users may be informed more promptly of changes in volume of
business activity or in the profit rate. Second, this method is likely to report a smoother income
stream in long- cycle operations. Income smoothing is said to occur when a business enterprise
selects from among acceptable alternative accounting methods to achieve income results that are
relatively stable (i.e. smooth) over time.
(ii) Completed Service Contract Method- Performance consists of the execution of a single act.
Alternatively, services are performed in more than a single act, and the services yet to be
performed are so significant in relation to the transaction taken as a whole that performance
cannot be deemed to have been completed until the execution of those acts. The completed
service contract method is relevant to those patterns of performance and accordingly revenue is
recognised when the sole or final act takes place and the service becomes chargeable. As an
alternative to percentage- completion method, the completed contract method may be used to
account for long- term construction projects. This method recognizes revenues upon final
approval of the project by the customer, i.e. in effect at delivery.
The completed contract method would be suitable for an entity engaged in many longterm projects some of which are completed each year. It should also be used in preference to the
percentage- completion method in cases in which reasonable estimates of future costs cannot be
made.
3. Use by Other of Enterprise Resources Yielding Interest, Royalties and Dividends.
The use by other of such enterprise resources gives rise to:
(i)
Interest . charges for the use of cash resources or amounts due to the enterprise;
(ii)
Royalties . charges for the use of such assets as know . how, patents, trademarks and
copyrights;
(iii)
Dividends . rewards from the holding of investments in shares.
Interest accrues, in most circumstances, on the time basis determined by the amount outstanding
and the rate applicable.
Usually, discount or premium on debt securities held is treated as though it were accruing over
the period to maturity.
Royalties accrue in accordance with the terms of the relevant agreement and are usually
recognised on the basis unless, having regard to the substance of the transactions, it is more
appropriate to recognise revenue on some other systematic and rational basis.
Dividends from investments in shares are not recognised in the statement of profit and loss until
a right to receive payment is established.
When interest, royalties and dividends from foreign countries require exchange permission and
uncertainty in remittance is anticipated, revenue recognition may need to be postponed.
4. Installment Method:

An exception to the general rule that revenues are realize and recognised concurrently is
the installment method. In this method, revenue realization (delivery) precedes revenue (profit)
recognition. Recognition is delayed through the devise of showing the gross profit on the
installment sale as .deferred. in the balance sheet. It is afforded later recognition in the income
statement proportionately to the collection of related receivable.
In the cost- recovery variation of the installment method, no profit is recognised until cost has
been recovered. Of all the revenue recognition alternatives, the cost- recovery one is the most
conservative since it provides for the latest possible revenue recognition.
5. Money Received or Amounts Paid in Advance:
Sometimes money is received or amounts are billed in advance of the delivery of goods
or rendering of services i.e. before revenue is to be recognised, e.g., rents or amount of magazine
subscriptions received in advance. Such items are rightly not treated as revenue of the period in
which they are received but as revenue of the future period or periods in which they are .earned..
These amounts are carried as .unearned revenue. i.e. liabilities, until the earning process is
complete. In the future periods when these amounts are recognised as revenues, it results in
recording a decrease in a liability rather than an increase in an asset.
Revenue Recognition and Realization Principle:
From the above discussion, it can be concluded that realisation principle primarily
determines the question of revenue recognition. Revenue recognised under the realization
principle is recorded at the amount received or expected to be received. The realization principle
requires that revenue be earned before it is recorded. This requirement usually causes no
problems because the earning process is usually complete or nearly complete by the time of the
required exchange. Mcferland defends realisation principle in recognition of revenue:
There are strong reasons why revenues reported in the summary income statement
should be realised revenues. The concept of realised revenue is consistent with the uses made of
the income statement by management and by investors. Since adherence to the realisation
concept brings revenues into close conformity with the current inflow of disposable funds from
sales, reported profits constitute a reliable measure of a companys ability to pay dividends, to
retire debt, or to increase shareholders equity and future profits by reinvesting earnings. The
realisation concept also helps to avoid the possible disastrous consequences which may follow if
financial obligations are undertaken in reliance on reported revenues which fail to materialize as
disposable funds.
Realisation, however, cannot take place by the holding of assets or as a result of the
production process alone. It is true that increases and decreases in asset values take place prior to
sale. However, these are only contingent values since their ultimate validation depends on
completion of the entire production and marketing cycle. Unrealised increases in assets values do
not produce any disposable funds for reinvestment in the business or for paying debt and
dividends. Consequently, the accountant regards historical cost inputs as invested capital and
ordinarily does not recognise changing values until realisation has occurred. Moreover, the
amounts of these unrealised increases can be supported only by circumstantial evidence drawn
from transactions to which the company owning the assets is not a party. A wide area for
subjective judgments exists in selecting pertinent transactions and the reliability of the
measurements of unrealised revenues is likely to be too low to merit the confidence placed in
external financial statements.

According to some writers, revenue realisation and revenue recognition. Although

sometimes recorded concurrently, are distinct accounting phenomena and distinct occurrences.
Revenue realisation occurs at the time of giving of goods or services by the entity in an
exchange. Revenue recognition is the identifying of revenue to be admitted to a given years
income statement. Most often, revenue realisation and recognition occur contemporaneously and
are recorded concurrently, i.e. in the same entry. However, in some specialised cases, it is
possible for revenue recognition to precede or to follow revenue realisation. Hendriksen feels
that much confusion prevails because of the realisation concept which seems to predate the
critical events giving rise to income. Hendriksen, therefore, advises to abandon the term
(realisation):
In its (realisation) place, emphasis should be placed on the reporting of valuation
changes of all types, although the nature of the change and the reliability of the measurement
should also be disclosed. Furthermore, accountants may be able to provide more relevant
information to users of external reports if less emphasis is placed on the relationship revenue to
net income and more emphasis on the informational content of the several measurements of
revenue. For example, it is likely that several attributes of revenue such as sales price of goods
produced, goods and services sold, and the final amount of cash received for goods and services
rendered-may be relevant to external users. Acceptance of one attribute should not necessarily
exclude disclosure of other attributes.
The American Accounting Associations Committee on Concept and Standards has
concluded that income should be reported as soon as the level of uncertainty has been reduced to
a tolerable level. The committee observes:
Realisation is not a determinant in the concept of income; it only serves as a guide in
deciding when events otherwise resolved as being within the concept of income, can be entered
in the accounting records in objectives terms; that is when the uncertainty has been reduced to an
acceptable level.
Measurement of Revenue
The amount of revenue arising on a transaction is usually determined by agreement
between the parties involved in the transaction. Revenue is recorded (measured) at the amount
received or expected to be received. When uncertainties exist regarding the determination of the
amount, or its associated costs, these uncertainties may influence the timing of revenue
recognition.
Under the present value of money concept revenue may mean the cash equivalent or the
present discounted value of the money claims to be received subsequently from the revenue
transaction. The present value of cash sales is equivalent to the amount of cash sales. For
example, if cash sales are Rs.1,000 the present value of this cash sales will also be Rs.1,000. But
if this amount is to be received after one year (not being a cash sale), payment of Rs.1,000 after
one year produce less than Rs.1,000 at the time of initial transaction. Therefore Rs.1,000 should
be discounted for the waiting period. In case, waiting period is short, future cash flows need not
to be discounted. If the waiting period is small, the discounted value and total revenue figure
may not significantly differ.

Expenses:
Like revenues, the determination of expenses is important in the computation of net
income, which show the result of ongoing major or central operations during an accounting
period. Expense, like revenues is a flow concept, representing the unfavorable changes in the
resources of a firm. But not all unfavorable changes are expenses. More precisely defined,
expenses are the using or consuming of goods and services in the process of obtaining revenues.
Under the asset/liability view, expenses are defined as decreases in the assets or
increases in liabilities arising from the use of economic resources and services during a given
period. Under the revenue/expense view, expenses comprise all the expired costs that correspond
to the revenues of the period.
The APB Statement No. 4 has defined expenses as gross decreases in assets or gross
increases in liabilities recognized and measured in conformity with generally accepted
accounting principles that result from those types of profit-directed activities of an enterprise that
can change owners equity. Most has raised three objections to this definition:
1. The word gross; what does it mean?
2. Any kind of decrease in assets or increase in liabilities can change owners equity, even
repayment of loan (gain or loss or retirement of debt).
3. As with revenues, definition of expenses in terms of changes in equity is less than helpful
if equity itself is a residual.
The FASBs definition of expenses is a usable one. It states that expenses are outflows or
other using up of assets, or incurrence of liabilities (or a combination of both) during a period
from delivering or producing goods, rendering services or carrying out other activities that
constitute the entitys ongoing major or central operations.
Some have objected to the absence of a reference to GAAP. It is felt that the reference is
implicit in these definitions.
The definition of expenses has been elaborated by describing the characteristics of
expenses of business enterprises in para 81 of SFAC No. 6. Expenses represent actual or
expected cash outflows (or the equivalent) that have occurred or will eventuate as a result of the
enterprises ongoing major or central operations during the period. The assets that flow out or are
used or the liabilities that are incurred may be of various kinds- for example, unit of product
delivered or produced, kilowatt hours of electricity used to light an office building, or taxes on
current income. Similarly, the transactions and events from which expenses arise and the
expenses themselves are in many forms and are called by various names- for example, cost of
gods sold, cost of services provided, depreciation, interest, rent and salaries and wagesdepending on the kinds of operations involved and the way expenses are recognized
We shall discuss below the following aspects relating to expenses:
1. the scope of term expense
2. measurement of expenses
3. recognition of expenses
4. reporting of expenses
Scope of Expense.:
In the FASB.s definition of expenses, only unfavourable changes incurred in the process
of obtaining revenues are included. The SFAC No. 6 has clearly distinguished between expenses

and losses. Losses result from transactions or events that are peripheral or incidental to the
operation of the enterprise. The expenses relate to ongoing major or central operations of the
enterprise. Only expenses can be matched with revenues of the period in the computation of
net operation income under the structural approach to income.
The all-inclusive concept of income includes all expenses and losses recognized during
the accounting period. The 1948 statement of AAA defined .expenses as consisting of both
operating costs and losses, i.e., asset expirations or asset reductions not related to the process of
providing goods or services to customers or clients were also classified as expenses. On the
other hand, the current operating concept excludes from the computation of net income those
expenses actually incurred in a prior period but not recognized until the current period, and all
losses. But Hendriksen point out that this is a problem of choosing a meaningful concept of
income rather than a problem of defining expenses.
Opinions differ on what should be included in expenses. Traditionally, sales returns and
allowances are normally treated as offsets. But sales discounts and bad debt losses have been
treated by accountants as expenses. Theoreticians, however, like them to be classified as offsets
to revenue rather than as expenses. In their opinion, sales discounts do not represent the use of
goods and services. The discount, they plead, is a reduction of the revenue and not a cost of
borrowing funds. So also, bad debt losses do not represent expirations of goods or services, but
rather reductions of the amount to be received in exchange of the product. They also hold that
costs incurred in the sale of share capital are not expenses, but are reductions of the amount of
capital received by the corporation. So also, the write-off capital stock discount has no place in
the income statement. Conventionally, however, most of these are treated as expenses for
determination of income.
Measurement of Expenses
There are many concepts of income depending upon the objectives of measurement.
Consequently, measurement of goods and services used in operations also depends upon the
definition of objectives. Those who defines expenses as decreases in the net assets of the firm, a
logical measurement is the value (exchange price) of the goods and services at the time they are
used in operations of the enterprise. On the other hand, those who emphasize the reporting of
cash flows of the enterprise usually suggest that expenses should be measured in terms of
transactions to which the firm is a party and measured by the past, current or future cash
expenditures. Generally, measurement of expenses is made on the basis of historical cost. But
due to volatile changes in prices, replacement cost or current cash equivalents have also been
proposed.
The primary reasons for still adhering to the conventional (historical cost) method of
measuring expenses are that they are mostly verifiable and that they represent the cost of the
goods and services at the time they were actually acquired by the firm.
Careful distinction must be made between expenditure, payment, expenses, and cost.
An expenditure is an outflow of assets, any resource, not just cash. A payment in an
outflow of cash. An expense is a using up of a resource during a period. A cost is a sacrifice
(including a using up) of a resource for a given purpose or object. .Basically cost is measured by
the current value of the economic resources given up or to be given up in obtaining the goods
and services to be used in operations.

Though historical cost, being more verifiable, is preferred by accountants its relevance is
suspect in times when the prices are not stable.
Current prices are recommended on the basis of the argument that as revenue is usually
measured in terms of current prices received for the product, the expenses matched against this
revenue should also be measured in terms of the current prices of the goods or services used or
consumed. This view has the merit of correctly assessing the results of operations by the
investors, creditors and other users. It separates income from holding gains"
There are two ways of obtaining current prices: (i) current liquidation (sale) price, and (ii)
replacement cost. If there is a good market in which the item can be purchased and sold, the
former may be relevant. The latter, however, may permit a more accurate prediction of the results
of the activity of the firm in future since it represents the acquisition price at the time of use.
However, if no market is available for the type of goods or services acquired, the replacement
cost may not be verifiable, and there may be a lot of subjectivity in its estimation or valuation.
Categories of Expenses
1. Cost of assets used to produce revenue:
Ex: selling and admin exp.
2. Expenses from non-reciprocal transfers and casualties:
Ex: Taxes, fires and theft.
3. Cost of assets other than products disposal of:
Ex: Plant & Equipment or
investment in other co.,)
4. Cost incurred in unsuccessful efforts.
Recognition of Expenses
Expenses, generally speaking, should be recognized in the period in which the associated
revenue is recognised. The SFAC No. 5 states that .expenses (and losses) are generally
recognized when an entitys economic benefits are used up in delivering or producing goods,
rendering services, or other activities that constitute its ongoing major or central operations or
when previously recognized assets are expected to provide reduced or no further benefits.
Consumption of economic benefits during a period may be recognised either directly or
by relating it to revenues recognised during the period:
1. Many expenses, such as selling and administrative salaries, are recognized during the period
in which cash is spent or liabilities are incurred for goods and services that are used up either
simultaneously with acquisition or soon after.
2. Some expenses, such as cost of goods sold, are matched with revenues-they are recognized
upon recognition of revenues that results directly and jointly from the same transactions or
other events as the expenses.
3. Some expenses, such as depreciation and insurance, are allocated by systematic and rational
procedures to the periods during which the related assets are expected to provide benefits .
An expense (or loss) is recognized if it becomes evident that previously recognized future
economic benefit of an asset have been reduced or eliminated, or that a liability has been
incurred or increased, without associated economic benefits.
Recognition principles:
1. Matching Process: One method of implementing the matching principle is known as
associating cause and effect. This implies that a clear and direct relationship exists
between the expense and the associated revenue. Cost of goods sold is a good example. A
retail store certainly cannot generate sales revenue without consuming inventory.

Salespersons commissions are another example. Because commissions are usually paid
as a percentage of sales revenue, commission expense is tied directly to revenue.
2. Systematic and Rational Allocation: Another method used to implement the matching
principle is systematic and rational allocation. Many costs cannot be directly linked to
specific revenue transactions. They can, however, be tied to a span of years and allocated
as an expense to each of those years. Sales equipment, as an example, is essential to
generate revenue. However, linking the cost of each display case, piece of furniture, and
the like to specific sales transactions is difficult. Instead, the equipments cost is
systematically allocated as depreciation expense to the years during which the equipment
helps generate revenue.
3. Immediate Recognition : The final method of applying the matching principle is
immediate recognition. Some expenditure have no discernible future benefit. In these
cases, the expenditure is expensed immediately. Officers salaries, utilities, and interest
are treated in this manner.

Gains and Losses:

Gains are defined as increase in net assets other than from revenues or from changes in
capital. Gains are increases in equity (net assets) from peripheral or incidental transactions of an
entity and from all other transactions and other events and circumstances affecting the entity
during a period except those that result from revenues or investment by owners. Losses are
decreases in equity (net assets) from peripheral or incidental transactions of an entity and from
all other transactions and other events and circumstances affecting the entity during a period
except those that result from expenses or distribution to owners. Gains and losses represent
favourable and unfavourable events not directly related to the normal revenue producing
activities of the enterprise. Revenue and expenses from other than sales of products,
merchandise, or service, such as disposition of assets may be separated from other revenue and
expenses and the net effects disclosed as gains or losses. Other examples of gains and losses are
sizeable write-downs of inventories, receivables, and capitalized research gains and losses on
sale of temporary investments, and gains and losses on foreign currency devaluations.
Features of Gains and Losses
Gains and losses possess the following characteristics:
1. Gains and losses result from enterprises incidental transactions and from other events and
circumstances stemming from the environment that may be largely beyond the control of
individual enterprises and their managements. Thus, gains and losses are not all alike.
They are of different types, even in a single enterprise.
2. Gains and losses may be described or classified according to sources. Some gains and
losses are net results of comparing the proceeds and sacrifices (costs) in incidental
transactions with other entities- for example, from sales of investments in marketable
securities, from disposition of used equipment, or from settlement of liabilities at other
than their carrying amounts. Other gains or losses result from non-reciprocal transfers
between an enterprise and other entities that are not its owners-for example, from gifts or
donations, from winning a law-suit, from thefts, and from assessments of fines or
damages by courts. Still other gains/losses result from holding assets or liabilities while
their value changes-for example, from price changes that cause inventory items to be

written down from cost to market, from changes in market prices of investments in
marketable equity securities accounted for at market values or at the lower of cost and
market, and from changes in foreign exchange rates. And still other gains or losses result
from other environmental factors, such as natural catastrophes (for example, damage to or
destruction of property by earthquake or food), technological changes (for example,
obsolescence).
3. Gains and losses may also be described as operating or non-operating depending on their
relation to an enterprises earning process. For example, losses on writing down inventory
from cost to market are usually considered to be operating losses, while losses from
disposing of segments of enterprises are usually considered non operating losses.
Other descriptions or classifications of gains and losses are also possible. A primary purpose
for describing or classifying gains and losses and for distinguishing them from revenues and
expenses associated with normal revenue-producing activities is to make displays of information
about an enterprises performance as useful as possible.
Recognition of Gains and Losses
The realization principle is more strictly followed in recognition of gains and losses.
Gains are not generally recognised until an exchange or sale has taken place. However, an
increase in the market value of securities may, under some circumstances, be sufficient evidence
to recognise a gain. However, some persons oppose recognizing appreciation in value due to two
reasons: (a) Increase in value is uncertain (b) An increase in value does not generate liquid
resources that can be used for payment of dividends. The emphasis on liquid resources and cash
flows, although useful for decision making purposes, may not be relevant for income
measurement purposes. Relative certainty and verifiability of measurements are satisfactory
guides for income measurement purposed. For investments in marketable securities, the
recognition of gains and losses arising from material changes in market prices is being accepted
in accounting although no sale or exchange might have taken place. However, change in value of
land is generally not recorded in accounting.
The criteria for recognition of losses are similar to the criteria for the recognition of
period expenses. Losses cannot be matched with revenue, so they should be recorded in the
period in which it becomes fairly definite that a given asset will provide less benefit to the firm
than indicated by the recorded valuation. In the case of sale of an asset or loss by fire or other
catastrophe, the timing of the events is fairly definite. If an asset has lost its usefulness, the loss
should be recognised and the final disposition should not be waited for. Loss arising should not
be carried forward to future periods. If it is fairly definite and if the amount of the loss can be
measured reasonably well, it should be recorded as soon as it is ascertainable.
Revenues, Expenses, Gains, and Losses -A comparison
The following points of differences are found with regard to revenues, expenses, gains
and losses.
1. Revenues and expenses are normally displayed gross, while gains and losses are
normally displayed net. For example, sales by a furniture manufacturer to furniture
jobbers usually result in displays in financial statements of both the inflow and outflows
aspects of the transactions-that is, both revenues and expenses are displayed. Revenues
are a gross amount reflecting actual or expected cash receipts from the sales. Expenses

2.

3.

4.

5.

are also a gross amount reflecting actual or expected cash outlays to make or buy the
assets sold. The expenses may then be deducted from the revenues to display a net
amount often called gross margin or gross profit on sales of product or output. If,
however, a pharmaceutical company or a theatre sells furniture, it normally displays only
the net gain or loss. That is, it deducts the carrying amount of the furniture sold from the
net proceeds of the sale before displaying the effects of the transaction and normally
displays only the net gain or loss from sale of capital assets.
Except for possible tax effects, some gains have no negative aspects, and some
losses have no positive aspects. For example, a gift may be received without a cost, or an
uninsured building may be damaged or destroyed by fire or flood with no proceeds.
These gains and losses are net in the sense that they show the end result of the transaction
or event rather than only its positive or negative aspects no further deductions are needed
to obtain the net effect, except perhaps for a tax effect if the gain or loss is not net of
taxes.
Some gains and losses may be considered operating gains and losses and may be closely
related to revenue and expenses. Revenues and expenses are commonly displayed as
gross inflows or outflows of net assets, while gains and losses are usually displayed as net
inflows or outflows.
Revenues and gains are similar in several ways, but some differences are significant,
especially in displaying information about an enterprises performance. Revenues and
expenses provide different kinds of information from gains and losses, or at least
information with a different emphasis. Revenues and expenses result from an enterprises
ongoing major or central operations and activities that constitute an enterprises earning
process-that is, from activities such as producing or delivering goods, rendering services,
lending, insuring, investing and financing. In contrast, gains and losses result from
incidental or peripheral transactions of an enterprise with other entities and from other
events and circumstances affecting it.
It is generally deemed useful or necessary to display both inflows and outflows aspects
(revenue and expenses) of the transactions and activities that constitute an enterprises
ongoing major or central earning process. In contrast, it is generally considered adequate
to display only the net results (gains or losses) of incidental or peripheral transactions or
of the effects of other events or circumstances affecting enterprises, although some details
may be disclosed in financial statement, in notes, or outside the financial statements.
Since a primary purpose of distinguishing gains and losses from revenues and expenses is
to make displays of information about an enterprises sources of comprehensive income
as useful as possible, fine distinctions between revenues and gains and between expenses
and losses are principally matters of meaningful reporting.
Distinctions between revenues and gains and between expenses and losses in a particular
enterprise depend to a significant extent on the nature of the enterprise, its operations, and
its other activities. Items that are revenues for one kind of enterprise are gains for another,
and items that are expenses for one kind of enterprises are losses for another. For
example, investments in securities that may be sources of revenues and expenses for
insurance or investment companies may be sources of gains and losses in manufacturing
or merchandising firms.
Sales of furniture result in revenues and expenses for a furniture manufacturer, a
furniture jobber, or a retail furniture store, which are selling products or inventories, but

usually result in gains or losses for an automobile manufacturer, a bank, a pharmaceutical

company, or a theatre, which are selling part of their facilities. Technological changes
may be sources of gains or losses to most kinds of enterprises but may be characteristic of
the operations of high technology or research-oriented enterprises. Events such as
commodity price changes and foreign exchange rate changes that occur while assets are
being used or produced or liabilities are owed may directly or indirectly affect the amount
of revenues or expenses for most enterprises, but they are sources of revenues or
expenses only for enterprises for which trading in foreign exchange or investing in
securities is a major or central activity.
Recognition of an Item in financial statements:
The term recognition has been earlier explained in relation to revenues, expenses, gains and
losses. An item to be recognised in financial statements, according to Financial Accounting
Standards Board (USA) should meet the following two criteria:
1. The item meets the definition of element of financial statements. The FASB recognises
the following as elements of financial statements: assets, liabilities, equity, investment by
owners, distribution to owners, comprehensive income, revenues, expense, changes in net
assets (applicable to non-business organization), gains and losses.
2. The item has a relevant attribute that can be measured with sufficient reliability. The
FASB uses the term .attribute. to describe the trait or aspect of a financial statement
element that is to be measured. In constructing its conceptual framework the FASB has
considered five possible attributes that might be used to represent assets and liabilities in
a balance sheet:
(a) Historical cost/historical proceeds
(b) Current cost/current proceeds
(c) Current market value
(d) Net realizable value
(e) Net present value of expected cash flows.
It has to be decided whether the most relevant attribute for investment and other
economic decisions is its costs to its present owner or some other attribute, such as its current
sale value or what it would currently cost to buy. The choice of an attribute is very important for
it is not only the representation of financial position in the balance sheet that is influenced. In
fact, measurement of assets and liabilities also enters into the measurement of revenues,
expenses, gains and losses, and most important earnings and other income concepts. Thus, every
important item in the financial statement is affected.
The above criteria are to be applied with due regard to a pervasive cost-benefit constraint
and a materiality threshold. It is not necessary to recognise an item if the costs of providing and
using the information about it exceed the benefits or if it is immaterial in amount.

Accounting policies
Definition:
1. Principles, rules and procedures selected, and consistently followed, by the
management of an organization (the accounting entity) in preparing and reporting the
financial statements. Accounting policies deal specifically with matters such as
consolidation of accounts, depreciation methods, goodwill, inventory pricing, and
research and development costs. Accounting policies must be disclosed in the annual
financial statements. See also summary of significant accounting policies.
2. Companies use accounting to record and report their financial transactions to outside
stakeholders. Accounting policies are developed by companies to ensure that all their
financial information is recorded according to standard accounting principles.
Accounting Standard (AS) 1 (issued 1979) Disclosure of Accounting Policies
The following is the text of the Accounting Standard (AS) 1 issued by the Accounting
Standards Board, the Institute of Chartered Accountants of India on Disclosure of Accounting
Policies. The Standard deals with the disclosure of significant accounting policies followed in
preparing and presenting financial statements.
In the initial years, this accounting standard will be recommendatory in character. During
this period, this standard is recommended for use by companies listed on a recognised stock
exchange and other large commercial, industrial and business enterprises in the public and
private sectors.2
Introduction
1. This statement deals with the disclosure of significant accounting policies followed in
preparing and presenting financial statements.
2. The view presented in the financial statements of an enterprise of its state of affairs and of the
profit or loss can be significantly affected by the accounting policies followed in the preparation
and presentation of the financial statements. The accounting policies followed vary from
enterprise to enterprise. Disclosure of significant accounting policies followed is necessary if the
view presented is to be properly appreciated.
3. The disclosure of some of the accounting policies followed in the preparation and presentation
of the financial statements is required by law in some cases.
4. The Institute of Chartered Accountants of India has, in Statements issued by it, recommended
the disclosure of certain accounting policies, e.g., translation policies in respect of foreign
currency items.
5. In recent years, a few enterprises in India have adopted the practice of including in their
annual reports to shareholders a separate statement of accounting policies followed in preparing
and presenting the financial statements.
6. In general, however, accounting policies are not at present regularly and fully disclosed in all
financial statements. Many enterprises include in the Notes on the Accounts, descriptions of
some of the significant accounting policies. But the nature and degree of disclosure vary
considerably between the corporate and the non-corporate sectors and between units in the same
sector.
7. Even among the few enterprises that presently include in their annual reports a separate
statement of accounting policies, considerable variation exists. The statement of accounting
policies forms part of accounts in some cases while in others it is given as supplementary
information.

8. The purpose of this Statement is to promote better understanding of financial statements by

establishing through an accounting standard the disclosure of significant accounting policies and
the manner in which accounting policies are disclosed in the financial statements. Such
disclosure would also facilitate a more meaningful comparison between financial statements of
different enterprises.
Nature of Accounting Policies
11. The accounting policies refer to the specific accounting principles and the methods of
applying those principles adopted by the enterprise in the preparation and presentation of
financial statements.
12. There is no single list of accounting policies which are applicable to all circumstances. The
differing circumstances in which enterprises operate in a situation of diverse and complex
economic activity make alternative accounting principles and methods of applying those
principles acceptable. The choice of the appropriate accounting principles and the methods of
applying those principles in the specific circumstances of each enterprise call for considerable
judgement by the management of the enterprise.
13. The various statements of the Institute of Chartered Accountants of India combined with the
efforts of government and other regulatory agencies and progressive managements have reduced
in recent years the number of acceptable alternatives particularly in the case of corporate
enterprises. While continuing efforts in this regard in future are likely to reduce the number still
further, the availability of alternative accounting principles and methods of applying those
principles is not likely to be eliminated altogether in view of the differing circumstances faced by
the enterprises.
Areas in Which Differing Accounting Policies are Encountered
The following are examples of the areas in which different accounting policies may be
adopted by different enterprises.
Methods of depreciation, depletion and amortisation
Treatment of expenditure during construction
Conversion or translation of foreign currency items
Valuation of inventories
Treatment of goodwill
Valuation of investments
Treatment of retirement benefits
Recognition of profit on long-term contracts
Valuation of fixed assets
Treatment of contingent liabilities.
Disclosure of Accounting Policies
To ensure proper understanding of financial statements, it is necessary that all significant
accounting policies adopted in the preparation and presentation of financial statements
should be disclosed.
Such disclosure should form part of the financial statements.
It would be helpful to the reader of financial statements if they are all disclosed as such
in one place instead of being scattered over several statements, schedules and notes.
Any change in an accounting policy which has a material effect should be disclosed. The
amount by which any item in the financial statements is affected by such change should

also be disclosed to the extent ascertainable. Where such amount is not ascertainable,
wholly or in part, the fact should be indicated. If a change is made in the accounting
policies which has no material effect on the financial statements for the current period
but which is reasonably expected to have a material effect in later periods, the fact of
such change should be appropriately disclosed in the period in which the change is
adopted.
Disclosure of accounting policies or of changes therein cannot remedy a wrong or
inappropriate treatment of the item in the accounts.
Facts: Generally Accepted Accounting Principles (GAAP) is a principlesbased accounting system. These are not specific rules to be followed but
standards that must be interpreted by accountants and applied to a
company's financial information through accounting policies.

Features: Accounting policies are the rules followed by accountants when

performing internal accounting functions. These rules cover the functions
of accounts payable, accounts receivable, fixed assets, reconciliations and
general accounting.

Considerations : When developing accounting policies, companies may

consult a Certified Public Accountant (CPA) to ensure that their accounting
policies accurately reflect the proper interpretation of GAAP standards.

Significance :
Because accounting policies vary from business to
business, financial statements must include disclosures and footnotes
explaining how certain accounting items are treated under the company's
accounting policy. This allows outside stakeholders to understand internal
accounting processes.

Expert Insight : The Financial Accounting Standards Board (FASB) is

responsible for issuing GAAP. FASB is the highest authority on accounting
standards in the United States.

Definition
A London-based organization which seeks to set and enforces standards for accounting
procedures. Over 100 countries currently require or permit companies to comply with IASB
standards. It is responsible for maintaining the International Financial Reporting Standards
(IFRS). The organization was preceded by the International Accounting Standards Committee
(IASC). See also Generally Accepted Accounting Principles (GAAP).
The International Accounting Standards Board (IASB) is an independent, privately-funded
accounting standard-setter based in London, England.
The IASB was founded on April 1, 2001 as the successor to the International Accounting
Standards Committee (IASC). It is responsible for developing International Financial Reporting
Standards (the new name for International Accounting Standards issued after 2001), and
promoting the use and application of these standards.
Foundation of the IASB
In April 2001, the International Accounting Standards Committee Foundation (IASCF),
since renamed as the IFRS Foundation, was formed as a not-for-profit corporation incorporated
in the US state of Delaware. The IFRS Foundation is the parent entity of the International
Accounting Standards Board (IASB), an independent accounting standard-setter based in
London, England.
On 1 March 2001, the IASB assumed accounting standard-setting responsibilities from its
predecessor body, the International Accounting Standards Committee (IASC). This was the
culmination of a restructuring based on the recommendations of the report Recommendations on
Shaping IASC for the Future.

The IASB structure has the following main features: the IFRS Foundation is an
independent organization having two main bodies, the Trustees and the IASB, as well as a IFRS
Advisory Council and the IFRS Interpretations Committee (formerly the IFRIC). The IASC
Foundation Trustees appoint the IASB members, exercise oversight and raise the funds needed,
but the IASB has responsibility for setting International Financial Reporting Standards
(international accounting standards).
IASB Members
The IASB has 15 Board members, each with one vote. They are selected as a group of
experts with a mix of experience of standard-setting, preparing and using accounts, and academic
work. At their January 2009 meeting the Trustees of the Foundation concluded the first part of
the second Constitution Review, announcing the creation of a Monitoring Board and the
expansion of the IASB to 16 members and giving more consideration to the geographical
composition of the IASB.
The IFRS Interpretations Committee has 14 members. Its brief is to provide timely
guidance on issues that arise in practice.
Role and Evolution of IASB:
"The role and history of the International Accounting Standards Board, including an
examination of the Board's evolution and stance on ethics issues."
The International Accounting Standards Board, (IASB), began life as the International
Accounting Standards Committee (IASC) in the 1973. The IASC was created in June 1973 as a
result of an agreement by the accountancy bodies of Australia, Canada, France, Germany, Japan,
Mexico, the Netherlands, the United Kingdom and Ireland and the United States. These countries
constituted the Board of IASC at that time.
The international professional activities of the accountancy bodies were organized under
the International Federation of Accountants (IFAC) in 1977. In 1981, IASC and IFAC agreed that
IASC would have full and complete autonomy in setting international accounting standards and
in publishing discussion documents on international accounting issues. At the same time, all
members of IFAC became members of IASC. This membership link was discontinued in May
2000 when IASC's Constitution was changed as part of the reorganization of IASC.
The main objective of the IASC was the development of International Accounting
Standards, in an effort to reduce the differences in accounting practices across countries.
Harmonization is the name given to the process of reducing differences in financial reporting
practices and increasing comparability of financial statements in various countries. As such the
intent of the IASC was to create a set of accounting rules that would be relevant and consistent to
all countries involved.
The IASC started with the ten board members above but gradually expanded this number and

also added associate members along the way. The first exposure draft was published in 1974 and
in 1981 the organization began to pay visits to national standard-setters in its efforts to reduce the
diversity of financial reporting practices.
Present status of Accounting Standards in India in harmonisation with the International
Accounting Standards:
As indicated earlier, Accounting Standards are formulated on the basis of the
International Financial Reporting Standards (IFRSs)/ International Accounting Standards (IASs)
issued by the IASB. Of the 41 IASs issued so far, 29 are at present in force, the remaining
standards have been withdrawn. Apart from this, 8 IFRSs have also been issued by the IASB.
Corresponding to the IASs/IFRSs, so far, 30 Indian Accounting Standards on the following
subjects have been issued: