FASB Concept stmt 5

Statement of Financial AccountingConcepts No. 5

Recognition and Measurement in FinancialStatements of Business Enterprises

Financial Accounting Standards Board

ORIGINAL

PRONOUNCEMENTS

AS AMENDED

Copyright © 2008 by Financial Accounting Standards Board. All rights reserved.No part of this publication may be reproduced, stored in a retrieval system, ortransmitted, in any form or by any means, electronic, mechanical, photocopying,recording, or otherwise, without the prior written permission of the FinancialAccounting Standards Board.

Statement of Financial Accounting Concepts No. 5Recognition and Measurement in FinancialStatements of Business Enterprises

STATUS

Issued: December 1984

Affects: No other pronouncements

Affected by: No other pronouncements

HIGHLIGHTS[Best understood in context of full Statement]

• This Statement sets forth recognition criteria and guidance on what information should be incorporated intofinancial statements and when. The Statement provides a basis for consideration of criteria and guidance byfirst addressing financial statements that should be presented and their contribution to financial reporting. Itgives particular attention to statements of earnings and comprehensive income. The Statement also addressescertain measurement issues that are closely related to recognition.

• Financial statements are a central feature of financial reporting—a principal means of communicating finan-cial information to those outside an entity. Some useful information is better provided by financial statementsand some is better provided, or can only be provided, by notes to financial statements, supplementary infor-mation, or other means of financial reporting. For items that meet criteria for recognition, disclosure by othermeans is not a substitute for recognition in financial statements.

• Recognition is the process of formally incorporating an item into the financial statements of an entity as anasset, liability, revenue, expense, or the like. A recognized item is depicted in both words and numbers, withthe amount included in the statement totals.

• A full set of financial statements for a period should show:

– Financial position at the end of the period

– Earnings for the period

– Comprehensive income for the period

– Cash flows during the period

– Investments by and distributions to owners during the period.

• Financial statements individually and collectively contribute to meeting the objectives of financial reporting.No one financial statement is likely to provide all the financial statement information that is useful for a par-ticular kind of decision.

• The parts of a financial statement also contribute to meeting the objectives of financial reporting and may bemore useful to those who make investment, credit, and similar decisions than the whole.

• Financial statements result from simplifying, condensing, and aggregating masses of data. As a result, theyconvey information that would be obscured if great detail were provided. Although those simplifications,condensations, and aggregations are both necessary and useful, the Board believes that it is important to avoidfocusing attention almost exclusively on “the bottom line,” earnings per share, or other highly simplifiedcondensations.

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• A statement of financial position provides information about an entity’s assets, liabilities, and equity and theirrelationships to each other at a moment in time. The statement delineates the entity’s resourcestructure—major classes and amounts of assets—and its financing structure—major classes and amounts ofliabilities and equity.

• Astatement of financial position does not purport to show the value of a business enterprise but, together withother financial statements and other information, should provide information that is useful to those who desireto make their own estimates of the enterprise’s value. Those estimates are part of financial analysis, not offinancial reporting, but financial accounting aids financial analysis.

• Statements of earnings and of comprehensive income together reflect the extent to which and the ways inwhich the equity of an entity increased or decreased from all sources other than transactions with owners dur-ing a period.

• The concept of earnings set forth in this Statement is similar to net income for a period in present practice;however, it excludes certain accounting adjustments of earlier periods that are recognized in the currentperiod—cumulative effect of a change in accounting principle is the principal example from present practice.The Board expects the concept of earnings to be subject to the process of gradual change or evolution that hascharacterized the development of net income.

• Earnings is a measure of entity performance during a period. It measures the extent to which asset inflows(revenues and gains) associated with cash-to-cash cycles substantially completed during the period exceedasset outflows (expenses and losses) associated, directly or indirectly, with the same cycles.

• Comprehensive income is a broad measure of the effects of transactions and other events on an entity, com-prising all recognized changes in equity (net assets) of the entity during a period from transactions and otherevents and circumstances except those resulting from investments by owners and distributions to owners.

• A variety of terms are used for net income in present practice. The Board anticipates that a variety of termswill be used in future financial statements as names for earnings (for example, net income, profit, or net loss)and for comprehensive income (for example, total nonowner changes in equity or comprehensive loss).

• Earnings and comprehensive income are not the same because certain gains and losses are included in com-prehensive income but are excluded from earnings. Those items fall into two classes that are illustrated bycertain present practices:

– Effects of certain accounting adjustments of earlier periods that are recognized in the current period (al-ready described)

– Certain other changes in net assets (principally certain holding gains and losses) that are recognized in theperiod but are excluded from earnings, such as some changes in market values of investments in market-able equity securities classified as noncurrent assets, some changes in market values of investments in in-dustries having specialized accounting practices for marketable securities, and foreign currency translationadjustments.

• The full set of financial statements discussed in this Statement is based on the concept of financial capitalmaintenance.

• Future standards may change what is recognized as components of earnings. Future standards may also rec-ognize certain changes in net assets as components of comprehensive income but not of earnings.

• A statement of cash flows directly or indirectly reflects an entity’s cash receipts classified by major sourcesand its cash payments classified by major uses during a period, including cash flow information about its op-erating, financing, and investing activities.

• A statement of investments by and distributions to owners reflects an entity’s capital transactions during aperiod—the extent to which and in what ways the equity of the entity increased or decreased from transac-tions with owners as owners.

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• An item and information about it should meet four fundamental recognition criteria to be recognized andshould be recognized when the criteria are met, subject to a cost-benefit constraint and a materiality threshold.Those criteria are:

– Definitions. The item meets the definition of an element of financial statements.

– Measurability. It has a relevant attribute measurable with sufficient reliability.

– Relevance. The information about it is capable of making a difference in user decisions.

– Reliability. The information is representationally faithful, verifiable, and neutral.

• Items currently reported in the financial statements are measured by different attributes (for example, histori-cal cost, current [replacement] cost, current market value, net realizable value, and present value of futurecash flows), depending on the nature of the item and the relevance and reliability of the attribute measured.The Board expects use of different attributes to continue.

• The monetary unit or measurement scale in current practice in financial statements is nominal units of money,that is, unadjusted for changes in purchasing power of money over time. The Board expects that nominalunits of money will continue to be used to measure items recognized in financial statements.

• Further guidance in applying the criteria for recognizing components of earnings is necessary because of thewidely acknowledged importance of earnings as a primary measure of entity performance. Guidance for rec-ognizing components of earnings is concerned with identifying which cycles are substantially complete andwith associating particular revenues, gains, expenses, and losses with those cycles.

• In assessing the prospect that as yet uncompleted transactions will be concluded successfully, a degree ofskepticism is often warranted.As a reaction to uncertainty, more stringent requirements have historically beenimposed for recognizing revenues and gains as components of earnings than for recognizing expenses andlosses. Those conservative reactions influence the guidance for applying the recognition criteria to compo-nents of earnings.

• Guidance for recognizing revenues and gains is based on their being:

– Realized or realizable. Revenues and gains are generally not recognized as components of earnings untilrealized or realizable and

– Earned. Revenues are not recognized until earned. Revenues are considered to have been earned when theentity has substantially accomplished what it must do to be entitled to the benefits represented by the rev-enues. For gains, being earned is generally less significant than being realized or realizable.

• Guidance for expenses and losses is intended to recognize:

– Consumption of benefit. Expenses are generally recognized when an entity’s economic benefits are con-sumed in revenue-earning activities or otherwise or

– Loss or lack of benefit. Expenses or losses are recognized if it becomes evident that previously recognizedfuture economic benefits of assets have been reduced or eliminated, or that liabilities have been incurred orincreased, without associated economic benefits.

• In a limited number of situations, the Board may determine that the most useful information results from rec-ognizing the effects of certain events in comprehensive income but not in earnings, and set standards accord-ingly. Certain changes in net assets that meet the fundamental recognition criteria may qualify for recognitionin comprehensive income even though they do not qualify for recognition as components of earnings.

• Information based on current prices should be recognized if it is sufficiently relevant and reliable to justify thecosts involved and more relevant than alternative information.

• Most aspects of current practice are consistent with the recognition criteria and guidance in this Statement, butthe criteria and guidance do not foreclose the possibility of future changes in practice. When evidence indi-cates that information that is more useful (relevant and reliable) than information currently reported is avail-able at a justifiable cost, it should be included in financial statements.

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Statement of Financial Accounting Concepts No. 5Recognition and Measurement in Financial Statements of Business Enterprises

STATEMENTS OF FINANCIALACCOUNTING CONCEPTS

This Statement of Financial Accounting Concepts isone of a series of publications in the Board’s conceptualframework for financial accounting and reporting. State-ments in the series are intended to set forth objectivesand fundamentals that will be the basis for developmentof financial accounting and reporting standards. The ob-jectives identify the goals and purposes of financial re-porting. The fundamentals are the underlying conceptsof financial accounting—concepts that guide the selec-tion of transactions, events, and circumstances to be ac-counted for; their recognition and measurement; and themeans of summarizing and communicating them to in-terested parties. Concepts of that type are fundamental inthe sense that other concepts flow from them and re-peated reference to them will be necessary in establish-ing, interpreting, and applying accounting and reportingstandards.

The conceptual framework is a coherent system of in-terrelated objectives and fundamentals that is expectedto lead to consistent standards and that prescribes the na-ture, function, and limits of financial accounting and re-porting. It is expected to serve the public interest by pro-viding structure and direction to financial accountingand reporting to facilitate the provision of evenhandedfinancial and related information that helps promote theefficient allocation of scarce resources in the economyand society, including assisting capital and other marketsto function efficiently.

Establishment of objectives and identification of fun-damental concepts will not directly solve financial ac-counting and reporting problems. Rather, objectives givedirection, and concepts are tools for solving problems.

The Board itself is likely to be the most direct benefi-ciary of the guidance provided by the Statements in thisseries. They will guide the Board in developing account-ing and reporting standards by providing the Board witha common foundation and basic reasoning on which toconsider merits of alternatives.

However, knowledge of the objectives and conceptsthe Board will use in developing standards also shouldenable those who are affected by or interested in finan-cial accounting standards to understand better the pur-poses, content, and characteristics of information pro-

vided by financial accounting and reporting. Thatknowledge is expected to enhance the usefulness of, andconfidence in, financial accounting and reporting. Theconcepts also may provide some guidance in analyzingnew or emerging problems of financial accounting andreporting in the absence of applicable authoritative pro-nouncements.

Statements of Financial Accounting Concepts do notestablish standards prescribing accounting procedures ordisclosure practices for particular items or events, whichare issued by the Board as Statements of Financial Ac-counting Standards. Rather, Statements in this series de-scribe concepts and relations that will underlie future fi-nancial accounting standards and practices and in duecourse serve as a basis for evaluating existing standardsand practices.*

The Board recognizes that in certain respects currentgenerally accepted accounting principles may be incon-sistent with those that may derive from the objectivesand concepts set forth in Statements in this series. How-ever, a Statement of Financial Accounting Conceptsdoes not (a) require a change in existing generally ac-cepted accounting principles; (b) amend, modify, or in-terpret Statements of Financial Accounting Standards,Interpretations of the FASB, Opinions of the AccountingPrinciples Board, or Bulletins of the Committee on Ac-counting Procedure that are in effect; or (c) justify eitherchanging existing generally accepted accounting and re-porting practices or interpreting the pronouncementslisted in item (b) based on personal interpretations of theobjectives and concepts in the Statements of FinancialAccounting Concepts.

Since a Statement of Financial Accounting Conceptsdoes not establish generally accepted accounting prin-ciples or standards for the disclosure of financial infor-mation outside of financial statements in published fi-nancial reports, it is not intended to invoke application ofRule 203 or 204 of the Rules of Conduct of the Code ofProfessional Ethics of theAmerican Institute of CertifiedPublic Accountants (or successor rules or arrangementsof similar scope and intent).†

Like other pronouncements of the Board, a Statementof Financial Accounting Concepts may be amended, su-perseded, or withdrawn by appropriate action under theBoard’s Rules of Procedure.

*Pronouncements such asAPB Statement No. 4, Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enter-prises, and the Accounting Terminology Bulletins will continue to serve their intended purpose—they describe objectives and concepts underly-ing standards and practices existing at the time of their issuance.†Rule 203 prohibits a member of the American Institute of Certified Public Accountants from expressing an opinion that financial statementsconform with generally accepted accounting principles if those statements contain a material departure from an accounting principle promul-gated by the Financial Accounting Standards Board, unless the member can demonstrate that because of unusual circumstances the financialstatements otherwise would have been misleading. Rule 204 requires members of the Institute to justify departures from standards promulgatedby the Financial Accounting Standards Board for the disclosure of information outside of financial statements in published financial reports.


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CONTENTS

ParagraphNumbers

HighlightsIntroduction, Scope, and Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1– 4Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5– 57

Financial Statements, Financial Reporting, and Recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5– 9Financial Statements and Objectives of Financial Reporting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10– 12Full Set of Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13– 14Purposes and Limitations of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15– 24

General Purpose Financial Statements and Individual Users . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15– 16Usefulness of Financial Statements, Individually and Collectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17– 24

Classification and Aggregation in Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20– 22Complementary Nature of Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23– 24

Individual Financial Statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25– 57Statement of Financial Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26– 29Statements of Earnings and Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30– 51

Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33– 38Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39– 41Relationships between Earnings and Comprehensive Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42– 44Financial Capital Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45– 48Recognition Implications of Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49– 51

Statement of Cash Flows. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52– 54Statement of Investments by and Distributions to Owners. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55– 57

Recognition Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58– 77Purposes of Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59– 60Structure of Recognition Criteria. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61– 62Fundamental Recognition Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63– 77

Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64Measurability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65– 72

Measurement Attributes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66– 70Monetary Unit or Measurement Scale. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71– 72

Relevance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73– 74Reliability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75– 77

Guidance in Applying Criteria to Components of Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78– 87Revenues and Gains. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83– 84Expenses and Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85– 87

Consumption of Benefits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86Loss or Lack of Future Benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

Recognition of Changes in Assets and Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88– 90Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91Appendix: Background Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92–108Summary Index of Concepts Defined or Discussed


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INTRODUCTION, SCOPE, ANDLIMITATIONS

1. This Statement sets forth fundamental recognitioncriteria and guidance on what information should beformally incorporated into financial statements andwhen. It builds on the foundation laid by earlier con-cepts Statements, bringing those concepts together toapply them to broad recognition issues. As a basis forconsidering recognition criteria, the Statement firstaddresses financial statements that should be pre-sented and how those financial statements contributeto the objectives of financial reporting. Both that dis-cussion and the later discussion of recognition giveparticular attention to statements of earnings andcomprehensive income.

2. The recognition criteria and guidance in thisStatement are generally consistent with current prac-tice and do not imply radical change. Nor do theyforeclose the possibility of future changes in practice.The Board intends future change to occur in thegradual, evolutionary way that has characterized pastchange.

3. This Statement also addresses certain measure-ment issues that are closely related to recognition.Measurement involves choice of an attribute bywhich to quantify a recognized item and choice of ascale of measurement (often called “unit of meas-ure”). The Statement notes that different attributes arecurrently used to measure different items in financialstatements and that the Board expects the use of dif-ferent attributes to continue. The Statement furthernotes that the measurement scale in current practiceis nominal units of money (that is, unadjusted forchanges in purchasing power over time) and that theBoard expects use of nominal units to continue.

4. This Statement is not intended to apply to organi-zations other than business enterprises. Recognitioncriteria and guidance on what information should beformally incorporated into financial statements ofnonbusiness organizations can be considered only af-ter completion of another Board project that concernssignificant underlying concepts upon which recogni-

tion criteria and guidance are built. The Board issuedits Exposure Draft, Proposed Amendments to FASBConcepts Statements 2 and 3 to Apply Them to Non-business Organizations, on July 7, 1983 and heldpublic hearings on that matter on November 14 and15, 1983. Since that project is still in progress, all ref-erences in this Statement are to the original State-ments, FASB Concepts Statements No. 2, Qualita-tive Characteristics of Accounting Information, andNo. 3, Elements of Financial Statements of BusinessEnterprises.

FINANCIAL STATEMENTS

Financial Statements, Financial Reporting, andRecognition

5. Financial statements are a central feature of finan-cial reporting—a principal means of communicatingfinancial information to those outside an entity. In ex-ternal general purpose financial reporting, a financialstatement is a formal tabulation of names andamounts of money derived from accounting recordsthat displays either financial position of an entity at amoment in time or one or more kinds of changes infinancial position of the entity during a period oftime. Items that are recognized in financial state-ments are financial representations of certain re-sources (assets) of an entity, claims to those resources(liabilities and owners’ equity), and the effects oftransactions and other events and circumstances thatresult in changes in those resources and claims. Thefinancial statements of an entity are a fundamentallyrelated set that articulate with each other and derivefrom the same underlying data.1

6. Recognition is the process of formally recordingor incorporating an item into the financial statementsof an entity as an asset, liability, revenue, expense, orthe like. Recognition includes depiction of an item inboth words and numbers, with the amount includedin the totals of the financial statements. For an assetor liability, recognition involves recording not onlyacquisition or incurrence of the item but also later

1FASB Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, pars. 6 and 18; Concepts Statement 3, pars. 6 and14 and 15. Financial position and changes in financial position are used here in a broad sense and do not refer to specific financial statements.“Used broadly, financial position refers to state or status of assets or claims to assets at moments in time, and changes in financial position refersto flows or changes in assets or claims to assets over time” (Concepts Statement 3, par. 14, footnote 6). “Through the financial accounting proc-ess, the myriad and complex effects of the economic activities of an enterprise are accumulated, analyzed, quantified, classified, recorded, sum-marized, and reported as information of two basic types: (1) financial position, which relates to a point in time, and (2) changes in financialposition, which relate to a period of time” (APB Statement No. 4, Basic Concepts and Accounting Principles Underlying Financial Statements ofBusiness Enterprises, par. 10).


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changes in it, including changes that result in re-moval from the financial statements.2

7. Although financial statements have essentially thesame objectives as financial reporting, some usefulinformation is better provided by financial statementsand some is better provided, or can only be provided,by notes to financial statements or by supplementaryinformation or other means of financial reporting:3

a. Information disclosed in notes or parentheticallyon the face of financial statements, such as signifi-cant accounting policies or alternative measuresfor assets or liabilities, amplifies or explains infor-mation recognized in the financial statements.4

That sort of information is essential to understand-ing the information recognized in financial state-ments and has long been viewed as an integralpart of financial statements prepared in accordancewith generally accepted accounting principles.

b. Supplementary information, such as disclosuresof the effects of changing prices, and other meansof financial reporting, such as management dis-cussion and analysis, add information to that inthe financial statements or notes, including infor-mation that may be relevant but that does not meetall recognition criteria.5

8. The scope of this concepts Statement is limited torecognition (and measurement) in financial state-ments. That limitation on scope does not alter the sta-tus of notes, supplementary information, or othermeans of financial reporting; those types of informa-tion remain important and useful for the reasons dis-cussed in the preceding paragraph. To clarify thescope of this concepts Statement, the diagram onpage CON5−8 illustrates the types of informationused in investment, credit, and similar decisions.

9. Since recognition means depiction of an item inboth words and numbers, with the amount included

in the totals of the financial statements, disclosure byother means is not recognition. Disclosure of infor-mation about the items in financial statements andtheir measures that may be provided by notes or par-enthetically on the face of financial statements, bysupplementary information, or by other means of fi-nancial reporting is not a substitute for recognition infinancial statements for items that meet recognitioncriteria. Generally, the most useful information aboutassets, liabilities, revenues, expenses, and other itemsof financial statements and their measures (that withthe best combination of relevance and reliability)should be recognized in the financial statements.

Financial Statements and Objectives of FinancialReporting

10. FASB Concepts Statement No. 1, Objectives ofFinancial Reporting by Business Enterprises, de-scribes the broad purposes of financial reporting, in-cluding financial statements.6 Financial reportingshould provide:

Information that is useful to present and potentialinvestors and creditors and other users in makingrational investment, credit, and similar decisions(paragraphs 34–36)

Information to help investors, creditors, and oth-ers assess the amounts, timing, and uncertainty ofprospective net cash inflows to the related enter-prise because their prospects for receiving cashfrom investments in, loans to, or other participa-tion in the enterprise depend significantly on itscash flow prospects (paragraphs 37–39)

Information about the economic resources of anenterprise, the claims to those resources (obliga-tions of the enterprise to transfer resources toother entities and owners’ equity), and the effects

2Concepts Statement 3, pars. 83, 6, 25, 26, and 34 and 35.3Concepts Statement 1, par. 5.4For example, notes provide essential descriptive information for long-term obligations, including when amounts are due, what interest theybear, and whether important restrictions are imposed by related covenants. For inventory, the notes provide information on the measurementmethod used— FIFO cost, LIFO cost, current market value, etc. For an estimated litigation liability, an extended discussion of the circumstances,counsel’s opinions, and the basis for management’s judgment may all be provided in the notes. For sales, useful information about revenuerecognition policies may appear only in the notes (FASB Statement No. 47, Disclosure of Long-Term Obligations; ARB No. 43, Chapter 4,“Inventory Pricing,” statement 8; FASB Statement No. 5, Accounting for Contingencies, par. 10; and APB Statement 4, par. 199).5Concepts Statement 1, pars. 6, 7, and 22. Supplementary financial statements, complete or partial, may be useful, especially to introduce and togain experience with new kinds of information. Criteria for including information in supplementary statements may have much in common withrecognition criteria for primary statements discussed here, but the criteria discussed in this Statement apply specifically to primary financialstatements.6Paragraphs 8–33 of Concepts Statement 1 give needed background. They describe factors affecting the objectives of general purpose externalfinancial reporting, such as characteristics of the environment in the United States, characteristics and limitations of information provided, poten-tial users and their interests, and the nature of the objectives. For example, “financial reporting is but one source of information needed by thosewho make economic decisions about business enterprises” (par. 22).


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of transactions, events, and circumstances thatchange resources and claims to those resources(paragraph 40).

11. Concepts Statement 1 also gives guidance aboutthe kinds of information that financial reporting, in-cluding financial statements, should provide:

Information about an enterprise’s economic re-sources, obligations, and owners’ equity (para-graph 41)

Information about an enterprise’s performanceprovided by measures of earnings and compre-hensive income7 and their components measuredby accrual accounting (paragraphs 42–48)

Information about how an enterprise obtains andspends cash, about its borrowing and repaymentof borrowing, about its capital (equity) transac-tions, including cash dividends and other distri-butions of enterprise resources to owners, andabout other factors that may affect an enterprise’sliquidity or solvency (paragraph 49)

Information about how management of anenterprise has discharged its stewardshipresponsibility to owners (stockholders) for theuse of enterprise resources entrusted to it (para-graphs 50–53).

12. A full, articulated set of several financial state-ments that provide those various kinds of informa-tion about an entity’s financial position and changesin its financial position is necessary to satisfy thebroad purposes of financial reporting.

Full Set of Financial Statements

13. The amount and variety of information that fi-nancial reporting should provide about an entity re-quire several financial statements. A full set of finan-cial statements for a period should show:

Financial position at the end of the period

Earnings (net income)8 for the period

Comprehensive income (total nonowner changesin equity)8 for the period

Cash flows during the period

Investments by and distributions to ownersduring the period.

Information about earnings, comprehensive income,cash flows, and transactions with owners have incommon that they are different kinds of informationabout the effects of transactions and other events andcircumstances that change assets and liabilities dur-ing a period.

14. This Statement does not consider details of dis-playing those different kinds of information and doesnot preclude the possibility that some entities mightchoose to combine some of that information in asingle statement. In present practice, for example, areconciliation of beginning and ending balances ofretained earnings is sometimes appended to an in-come statement.

Purposes and Limitations of FinancialStatements

General Purpose Financial Statements andIndividual Users

15. General purpose financial statements, to whichthe objectives of financial reporting apply, are di-rected toward the common interest of various poten-tial users in the ability of a business enterprise to gen-erate favorable cash flows.9 General purposefinancial statements are feasible only because groupsof users of financial information have generally simi-lar needs. But “general purpose” does not mean “allpurpose,” and financial statements do not necessarilysatisfy all users equally well.

16. Each decision maker judges what accounting in-formation is useful, and that judgment is influencedby factors such as the decisions to be made, the meth-ods of decision making to be used, the informationalready possessed or obtainable from other sources,and the decision maker’s capacity (alone or with pro-fessional help) to process the information. Even users

7Concepts Statement 3 used the term comprehensive income for the concept that was called earnings in Concepts Statement 1 and reserved theterm earnings for possible use to designate a component part of comprehensive income (par. 1, footnote 1). Earnings, including its relationship tocomprehensive income, is a major topic of this Statement.8Pars. 33 and 40.9Concepts Statement 1, par. 30.


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of financial statement information who make gener-ally similar kinds of decisions differ from each otherin those matters.10

Usefulness of Financial Statements, Individuallyand Collectively

17. Financial statements of an entity individuallyand collectively contribute to meeting the objectivesof financial reporting. Component parts of financialstatements also contribute to meeting the objectives.

18. Each financial statement provides a differentkind of information, and, with limited exceptions(paragraph 14), the various kinds of information can-not be combined into a smaller number of statementswithout unduly complicating the information. More-over, the information each provides is used for vari-ous purposes, and particular users may be especiallyinterested in the information in one of the statements.Paragraphs 26–57 of this Statement summarize howindividual financial statements provide the informa-tion listed in paragraph 13.

19. The following two sections first describe howclassification and aggregation, if done and used withcare, enhance the decision usefulness of financialstatements and how financial statements complementeach other.

Classification and aggregation in financialstatements

20. Classification in financial statements facilitatesanalysis by grouping items with essentially similarcharacteristics and separating items with essentiallydifferent characteristics. Analysis aimed at objectivessuch as predicting amounts, timing, and uncertaintyof future cash flows requires financial informationsegregated into reasonably homogeneous groups. Forexample, components of financial statements thatconsist of items that have similar characteristics inone or more respects, such as continuity or recur-rence, stability, risk, and reliability, are likely to havemore predictive value than if their characteristics aredissimilar.

21. Financial statements result from processing vastmasses of data and involve needs to simplify, to con-dense, and to aggregate.11 Real things and events thataffect a dynamic and complex business enterprise arerepresented in financial statements by words andnumbers, which are necessarily highly simplifiedsymbols of the real thing. Real transactions andother events are voluminous and are interpreted,combined, and condensed to be reflected in financialstatements. Numerous items and componentsare aggregated into sums or totals. The resulting fi-nancial statements convey information that would beobscured from most users if great detail, suchas descriptions of each transaction or event, wereprovided.

22. Although those simplifications, condensations,and aggregations are both necessary and useful, theBoard believes it is important to avoid focusing atten-tion almost exclusively on “the bottom line,” earn-ings per share, or other highly simplified condensa-tions. Summary data, such as the amounts of netassets, comprehensive income, earnings, or earningsper share, may be useful as general indicators of theamount of investment or overall past performanceand are often used in efforts to compare an entitywith many other entities. But, in a complex businessenterprise, summary amounts include many hetero-geneous things and events. Components of a finan-cial statement often reflect more homogeneousclasses of items than the whole statement. The indi-vidual items, subtotals, or other parts of a financialstatement may often be more useful than the aggre-gate to those who make investment, credit, andsimilar decisions.

Complementary nature of financial statements

23. Financial statements interrelate (articulate) be-cause they reflect different aspects of the sametransactions or other events affecting an entity.12 Al-though each presents information different from theothers, none is likely to serve only a single purpose orprovide all the financial statement informationthat is useful for a particular kind of assessment ordecision. Significant tools of financial analysis, such

10Concepts Statement 2, pars. 23–26 and 32–41. For example, information cannot be useful to decision makers who cannot understand it, eventhough it may otherwise be relevant to a decision and be reliable. Understandability of information is related to the characteristics of the decisionmaker as well as to the characteristics of the information itself.11“. . . It is a very fundamental principle indeed that knowledge is always gained by the orderly loss of information, that is, by condensing andabstracting and indexing the great buzzing confusion of information that comes from the world around us into a form which we can appreciateand comprehend” (Kenneth E. Boulding, Economics as a Science [New York: McGraw-Hill Book Company, 1970], p. 2, emphasis added).12Concepts Statement 3, pars. 14 and 15.


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as rates of return and turnover ratios, depend on inter-relationships between financial statements and theircomponents.

24. Financial statements complement each other. Forexample:

a. Statements of financial position include informa-tion that is often used in assessing an entity’s li-quidity and financial flexibility,13 but a statementof financial position provides only an incompletepicture of either liquidity or financial flexibilityunless it is used in conjunction with at least a cashflow statement.

b. Statements of earnings and comprehensive in-come generally reflect a great deal about the prof-itability of an entity during a period, but that infor-mation can be interpreted most meaningfully orcompared with that of the entity for other periodsor that of other entities only if it is used in con-junction with a statement of financial position, forexample, by computing rates of return on assets orequity.

c. Statements of cash flows commonly show a greatdeal about an entity’s current cash receipts andpayments, but a cash flow statement provides anincomplete basis for assessing prospects for futurecash flows because it cannot show interperiod re-lationships. Many current cash receipts, especiallyfrom operations, stem from activities of earlier pe-riods, and many current cash payments are in-tended or expected to result in future, not current,cash receipts. Statements of earnings and compre-hensive income, especially if used in conjunctionwith statements of financial position, usually pro-vide a better basis for assessing future cash flowprospects of an entity than do cash flow state-ments alone.14

d. Statements of investments by and distributions toowners provide information about significantsources of increases and decreases in assets, li-abilities, and equity, but that information is of littlepractical value unless used in conjunction withother financial statements, for example, by com-paring distributions to owners with earnings andcomprehensive income or by comparing invest-ments by and distributions to owners withborrowings and repayments of debt.

Individual Financial Statements

25. This discussion summarizes how individualfinancial statements provide the information listed inparagraph 13. It also introduces recognition con-siderations, which are the subject of the sectionsfollowing.

Statement of Financial Position

26. A statement of financial position provides infor-mation about an entity’s assets, liabilities, and equityand their relationships to each other at a moment intime. The statement delineates the entity’s resourcestructure—major classes and amounts of assets—andits financing structure—major classes and amountsof liabilities and equity.

27. A statement of financial position does not pur-port to show the value of a business enterprise15 but,together with other financial statements and other in-formation, should provide information that is usefulto those who desire to make their own estimates ofthe enterprise’s value. As a result of limitations stem-ming from uncertainty and cost-benefit consider-ations, not all assets and not all liabilities are includedin a statement of financial position, and some assetsand liabilities that are included are affected by events,such as price changes or accretion, that are not recog-nized. Statements of financial position also com-monly use different attributes to measure different as-sets and liabilities.16

28. Uncertainty and related limitations of financialaccounting put the burden of estimating values ofbusiness enterprises and of investments in them oninvestors, creditors, and others. Information aboutcomponents of earnings and comprehensive incomeoften plays a significant part in that analysis. For ex-ample, investors may use that information to help es-timate “earning power,” or other amounts that theyperceive as representative of long-term earning abil-ity of an enterprise, as a significant step in comparingthe market price of an equity security with its “intrin-sic value.” Those estimates and analyses are part of

13Liquidity reflects an asset’s or liability’s nearness to cash. Financial flexibility is the ability of an entity to take effective actions to alter amountsand timing of cash flows so it can respond to unexpected needs and opportunities.14Concepts Statement 1, pars. 42–46.15Ibid., par. 41.16The different attributes are defined and their current use illustrated in paragraphs 66–70 of this Statement.


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financial analysis, not financial reporting,17 but fi-nancial accounting facilitates financial analysis by,among other things, classifying financial statementinformation in homogeneous groups.18

29. Important uses of information about an entity’sfinancial position include helping users to assess fac-tors such as the entity’s liquidity, financial flexibility,profitability, and risk. Comparisons among entitiesand computations of rates of return are enhanced tothe extent that significant asset and liability group-ings are homogeneous in general characteristics andmeasurement.

Statements of Earnings and ComprehensiveIncome

30. Statements of earnings and comprehensive in-come together reflect the extent to which and theways in which the equity of an entity increased or de-creased from all sources other than transactions withowners during a period. Investors, creditors, manag-ers, and others need information about the causesof changes in an entity’s assets and liabilities—including results of its ongoing major or central op-erations, results of its incidental or peripheral transac-tions, and effects of other events and circumstancesstemming from the environment that are often partlyor wholly beyond the control of the entity and itsmanagement.

31. Effects of an entity’s various activities, transac-tions, and events differ in stability, risk, and predict-ability, indicating a need for information about vari-ous components of earnings and comprehensiveincome. That need underlies the distinctions betweenrevenues and gains, between expenses and losses, be-tween various kinds of gains and losses, and between

measures found in present practice such as incomefrom continuing operations and net income.19

32. Since the parts of a financial statement may bemore useful to decision makers than the whole (para-graphs 20–22), this Statement emphasizes usefulnessof components, interrelationships, and different per-spectives as well as usefulness, collectively and indi-vidually, of financial statements.

Earnings

33. The concept of earnings described in this State-ment is similar to net income in present practice. Itincludes almost all of what is in present net incomefor a period, and a statement of earnings based on itwill be much like a present income statement.Present practice accepts a variety of terms for net in-come, and the Board anticipates that net income,profit, net loss, and other equivalent terms will con-tinue to be used in financial statements as names forearnings. However, earnings is not exactly the sameas present net income, and this Statement uses theterm earnings in part to distinguish the concept de-scribed here from present net income.

34. Earnings does not include the cumulative effectof certain accounting adjustments of earlier periodsthat are recognized in the current period.20 The prin-cipal example that is included in present net incomebut excluded from earnings is the cumulative effectof a change in accounting principle, but others maybe identified in the future. Earnings is a measure ofperformance for a period and to the extent feasibleexcludes items that are extraneous to thatperiod—items that belong primarily to other peri-ods.21 The following condensed statements show thesimilarities and major existing difference betweenearnings and present net income.

17“. . . [A]ccrual accounting provides measures of earnings rather than evaluations of management’s performance, estimates of ‘earning power,’predictions of earnings, assessments of risk, or confirmations or rejections of predictions or assessments. Investors, creditors, and other users ofthe information do their own evaluating, estimating, predicting, assessing, confirming, or rejecting. For example, procedures such as averaging ornormalizing reported earnings for several periods and ignoring or averaging out the financial effects of ‘nonrepresentative’ transactions andevents are commonly used in estimating ‘earning power.’ However, both the concept of ‘earning power’ and the techniques for estimating it arepart of financial analysis and are beyond the scope of financial reporting” (Concepts Statement 1, par. 48).18Pars. 20–22 of this Statement.19Concepts Statement 3, pars. 61 and 151.20That is, the cumulative effect on equity at the beginning of the period for which an earnings statement is provided, sometimes called a“catch-up adjustment.”21Prior period adjustments as defined in FASB Statement No. 16, Prior Period Adjustments, are not included in net income in present practiceand are not, therefore, differences between earnings in this Statement and present net income. Statement 16 narrowed considerably the definitionof prior period adjustments in APB Opinions No. 9, Reporting the Results of Operations, and No. 30, Reporting the Results ofOperations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions. Some items that were prior period adjustments under those Opinions are included in net income in present practice, and someargue that the existing definition is too narrow because as a result net income includes items that belong to other periods.


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PresentNet Income Earnings

Revenues 100 100Expenses 80 80Gain from unusual source (3) (3)Income from continuing operations 23 23Loss on discontinued operations

Income from operating discontinued segment 10 10Loss on disposal of discontinued segment 12 2 12 2

Income before extraordinary items 21and effect of a change in accounting principle 21Extraordinary loss 6 6Cumulative effect on prior years of a changein accounting principle 2 8

Earnings 15

Net Income 13

35. The Board expects the concept of earnings to besubject to the process of gradual change or evolutionthat has characterized the development of net in-come. Present practice has developed over a longtime, and that evolution has resulted in significantchanges in what net income reflects, such as a shifttoward what is commonly called an “all-inclusive”income statement. Those changes have resulted pri-marily from standard-setting bodies’ responses toseveral factors, such as changes in the business andeconomic environment and perceptions about the na-ture and limitations of financial statements, about theneeds of users of financial statements, and about theneed to prevent or cure perceived abuse(s) in finan-cial reporting. Those factors sometimes may conflictor appear to conflict. For example, an all-inclusive in-come statement is intended, among other things, toavoid discretionary omissions of losses (or gains)from an income statement, thereby avoiding presen-tation of a more (or less) favorable report of perform-ance or stewardship than is justified. However, be-cause income statements also are used as a basis forestimating future performance and assessing futurecash flow prospects, arguments have been advancedurging exclusion of unusual or nonrecurring gains

and losses that might reduce the usefulness of an in-come statement for any one year for predictivepurposes.

36. Earnings is a measure of performance during aperiod that is concerned primarily with the extent towhich asset inflows associated with cash-to-cashcycles22 substantially completed (or completed) dur-ing the period exceed (or are less than) asset outflowsassociated, directly or indirectly, with the samecycles. Both an entity’s ongoing major or central ac-tivities and its incidental or peripheral transactions in-volve a number of overlapping cash-to-cash cycles ofdifferent lengths. At any time, a significant propor-tion of those cycles is normally incomplete, and pros-pects for their successful completion and amounts ofrelated revenues, expenses, gains, and losses vary indegree of uncertainty. Estimating those uncertain re-sults of incomplete cycles is costly and involvesrisks, but the benefits of timely financial reportingbased on sales or other more relevant events, ratherthan on cash receipts or other less relevant events,outweigh those costs and risks.

37. Final results of incomplete cycles usually can bereliably measured at some point of substantialcompletion (for example, at the time of sale, usually

22The patterns of cash-to-cash cycles vary by industry. “Descriptions of operations of business enterprises commonly describe a cycle that beginswith cash outlays and ends with cash receipts. That description . . . generally fits manufacturing, merchandising, financial, and service enterpriseswhose operations comprise primarily activities such as acquiring goods and services, increasing their value by adding time, place, or form utility,selling them, and collecting the selling price. Cash receipts may precede cash payments, however, and commonly do in the operations of someservice and financial enterprises” (Concepts Statement 1, par. 39, footnote 8).


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meaning delivery) or sometimes earlier in the cycle(for example, as work proceeds on certain long-term,construction-type contracts), so it is usually not nec-essary to delay recognition until the point of fullcompletion (for example, until after receivables havebeen collected and warranty obligations have beensatisfied). Guidance for applying recognition criteriato components of earnings (paragraphs 78–87)helps define earnings by aiding in making thosedeterminations.

38. Earnings focuses on what the entity has receivedor reasonably expects to receive for its output (rev-enues) and what it sacrifices to produce and distributethat output (expenses). Earnings also includes resultsof the entity’s incidental or peripheral transactionsand some effects of other events and circumstancesstemming from the environment (gains and losses).23

Comprehensive income

39. Comprehensive income is a broad measure ofthe effects of transactions and other events on an en-tity, comprising all recognized changes in equity (netassets) of the entity during a period from transactionsand other events and circumstances except those re-sulting from investments by owners and distributionsto owners.24

40. Just as a variety of terms are used for net incomein present practice, the Board anticipates that totalnonowner changes in equity, comprehensive loss,and other equivalent terms will be used in future fi-nancial statements as names for comprehensiveincome.

41. Components of comprehensive incomeother than those that are included in earningspresent no recognition problems in addition to thoseinvolved in recognizing assets and liabilities, for

which fundamental criteria are described later(paragraphs 58–77).

Relationships between earnings andcomprehensive income

42. Earnings and comprehensive income have thesame broad components—revenues, expenses, gains,and losses—but are not the same because certainclasses of gains and losses are included in compre-hensive income but are excluded from earnings.25

Those items fall into two classes that are illustratedby certain present practices:

a. Effects of certain accounting adjustments of ear-lier periods that are recognized in the period, suchas the principal example in present practice—cumulative effects of changes in accountingprinciples—which are included in present net in-come but are excluded from earnings as set forthin this Statement (paragraphs 33 and 34)

b. Certain other changes in net assets (principallycertain holding gains and losses) that are recog-nized in the period, such as some changes in mar-ket values of investments in marketable equity se-curities classified as noncurrent assets, somechanges in market values of investments in indus-tries having specialized accounting practices formarketable securities, and foreign currency trans-lation adjustments.26

Both classes and the items they comprise are subjectto evolutionary change (paragraph 35).

43. Differences between earnings and comprehen-sive income require some distinguishing terms. Theitems in both classes described in paragraph 42 aregains and losses under the definitions in ConceptsStatement 3 (paragraphs 67–73), but to refer to somegains and losses that are included in earnings andother gains and losses that are included in compre-hensive income but are excluded from earnings is not

23Concepts Statement 3, paragraphs 50 and 63–73, defines revenues, expenses, gains, and losses.24Ibid., pars. 50, 56–62, and 147–152.25That possibility was noted in Concepts Statement 3: “. . . the reason for using comprehensive income rather than earnings in this Statement isthat the Board has decided to reserve earnings for possible use to designate a different concept that is a component part of—that is, is narrowerthan or less than—comprehensive income. . . .” (par. 58, footnote reference omitted).26FASB Statements No. 12, Accounting for Certain Marketable Securities; No. 60, Accounting and Reporting by Insurance Enterprises; andNo. 52, Foreign Currency Translation. Changes in market values of marketable securities are included in earnings by some other entities havingspecialized accounting practices for marketable securities (for example, securities brokers and dealers and investment companies) and for someclasses of marketable securities (for example, securities held in trading accounts of banks and futures contracts that are considered speculative[FASB Statement No. 80, Accounting for Futures Contracts]).


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only clumsy but also likely to be confusing. ThisStatement therefore uses gains and losses for thoseincluded in earnings and uses cumulative accountingadjustments and other nonowner changes in equityfor those excluded from earnings but included incomprehensive income.

44. The relationships between earnings and compre-hensive income described in the foregoing para-graphs mean that statements of earnings and compre-hensive income complement each other somethinglike this:27

+ Revenues 100 + Earnings 15

–Expenses 80 – Cumulative accounting

adjustments 2+ Gains 3

– Losses 8+ Other nonowner

changes in equity 1

= Earnings 15 = Comprehensive income 14

Financial capital maintenance

45. The full set of articulated financial statementsdiscussed in this Statement is based on the concept offinancial capital maintenance.

46. An enterprise receives a return only after its capi-tal has been maintained or recovered. The concept ofcapital maintenance, therefore, is critical in distin-guishing an enterprise’s return on investment fromreturn of its investment. Both investors and the enter-prises in which they acquire an interest invest finan-cial resources with the expectation that the invest-ment will generate more financial resources than theyinvested.

47. A return on financial capital results only if the fi-nancial (money) amount of an enterprise’s net assetsat the end of a period exceeds the financial amount ofnet assets at the beginning of the period after exclud-ing the effects of transactions with owners. The fi-nancial capital concept is the traditional view and isthe capital maintenance concept in present financialstatements.28 In contrast, a return on physical capitalresults only if the physical productive capacity of theenterprise at the end of the period (or the resourcesneeded to achieve that capacity) exceeds the physicalproductive capacity at the beginning of the period,also after excluding the effects of transactions withowners. The physical capital maintenance conceptcan be implemented only if inventories and property,

plant, and equipment (and perhaps other assets) aremeasured by their current costs, while the financialcapital maintenance concept does not require meas-urement by a particular attribute.

48. The principal difference between the two capitalmaintenance concepts involves the effects of pricechanges during a period on assets while held and li-abilities while owed. Under the financial capital con-cept, if the effects of those price changes are recog-nized, they are conceptually holding gains and losses(though they are commonly reported under othernames)29 and are included in the return on capital.Under the physical capital concept, those changeswould be recognized but conceptually would be capi-tal maintenance adjustments that would be includeddirectly in equity and not included in return on capi-tal. Both earnings and comprehensive income as setforth in this Statement, like present net income, in-clude holding gains and losses that would be ex-cluded from income under a physical capital mainte-nance concept.

Recognition implications of earnings

49. Although recognition involves considerations ofrelevance and comparability, recognition criteria,conventions, and rules are primarily intended to in-crease reliability—they are means of coping with theuncertainty that surrounds business and economic ac-tivities. Uncertainty in business and economic affairs

27Earnings and its components are the same as in the example in paragraph 34. Both cumulative accounting adjustments and other nonownerchanges in equity may be either additions to or deductions from earnings. The signs used in the example are for illustration only.28Concepts Statement 3, par. 58. “Comprehensive income as defined in paragraph 56 is a return on financial capital” (Ibid.).29For example, under the FIFO method in present practice, gains from price increases on inventory while held reduce cost of goods sold.


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is a continuum, ranging from mere lack of absolutesureness to a degree of vagueness that precludes any-thing other than guesswork. Since uncertainty sur-rounds an entity’s incomplete cash-to-cash cycles invarying degrees, measuring progress reliably in-volves determining whether uncertainty about futurecash flows has been reduced to an acceptable level.

50. In response to uncertainty, there has been a gen-eral tendency to emphasize purchase and sale trans-actions and to apply conservative procedures in ac-counting recognit ion. Perceptions aboutcharacteristics such as realizability and volatility mayalso help to explain why some events are recognizedin present practice while others are not. For example,revenues are sometimes recognized before sale ifreadily realizable (if sale is a more-or-less effortlessor perfunctory activity, and uncertainty aboutamounts involved is reduced to an acceptable levelby quoted prices for interchangeable units in activemarkets or other reliable measures).30 Those charac-teristics may also help to explain certain special rec-ognition rules. For example, so-called translation ad-justments from translating foreign currency financialstatements are excluded from net income but are re-ported separately in comprehensive income (para-graphs 39 and 42) because they are considered notonly unrealized but also unrealizable short of sale orliquidation of the investment in the entity. Effects ofexchange rate changes on the net investment are con-sidered too uncertain and remote to be included inoperating results.31 Similarly, a reason commonlygiven for the same treatment for certain changes inmarket values of investments in marketable equitysecurities is that they may be temporary, and tempo-rary fluctuations in market values of long-term in-vestments should not be included in net income.32

51. Since earnings in this Statement is similar to netincome for a period in present practice, criteria andguidance given in the Statement for recognizingcomponents of earnings (paragraphs 58–87) are gen-erally similar to revenue and expense recognition cri-teria or rules in present practice. Future standardsmay change what is recognized as components ofearnings (paragraph 35). Moreover, because of the

differences between earnings and comprehensive in-come, future standards also may recognize certainchanges in net assets as components of comprehen-sive income but not as components of earnings.33

Statement of Cash Flows

52. A statement of cash flows directly or indirectlyreflects an entity’s cash receipts classified by majorsources and its cash payments classified by majoruses during a period. It provides useful informationabout an entity’s activities in generating cash throughoperations to repay debt, distribute dividends, or rein-vest to maintain or expand operating capacity; aboutits financing activities, both debt and equity; andabout its investing or spending of cash. Importantuses of information about an entity’s current cash re-ceipts and payments include helping to assess factorssuch as the entity’s liquidity, financial flexibility,profitability, and risk.

53. Since neither earnings nor comprehensive in-come measured by accrual accounting is the same ascash flow from operations, cash flow statements pro-vide significant information about amounts, causes,and intervals of time between earnings and compre-hensive income and cash receipts and outlays. Userscommonly consider that information in assessing therelationship between earnings or comprehensive in-come and associated cash flows.

54. Statements of cash flows present few recognitionproblems because all cash receipts and payments arerecognized when they occur. Reporting cash flowsinvolves no estimates or allocations and few judg-ments except regarding classification in cash flowstatements.34

Statement of Investments by and Distributions toOwners

55. A statement of investments by and distributionsto owners reflects the extent to which and in whatways the equity of an entity increased or decreased

30ARB No. 43, Chapter 4, par. 16; FASB Statement 12, pars. 14–16, 27, and 28.31Statement 52, pars. 111–113.32Statement 12, pars. 21, 29, and 30.33A possibility that has been suggested is the “inventory profits” that would result if cost of goods sold were reported on LIFO while inventorieswere reported on FIFO.34Determinations about the particular items to be reported within cash flow statements and the form of those statements are matters that may bedeveloped further in Statements of Financial Accounting Standards or in practice.


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from transactions with owners as owners35 during aperiod. That is, it reflects the capital transactions36 ofthe entity, in contrast to its income transactions—those with nonowners—which are reflected in state-ments of earnings and comprehensive income. State-ments of comprehensive income and statements oftransactions with owners together include all changesin equity (net assets) recognized during a period.

56. Investments by owners establish or increaseownership interests in the entity and may be receivedin the form of cash, goods or services, or satisfactionor conversion of the entity’s liabilities. Distributionsdecrease ownership interests and include not onlycash dividends when declared (or other cash with-drawals by owners of noncorporate entities) but alsotransactions such as reacquisitions of the entity’s eq-uity securities and distributions “in kind” of noncashassets. Information about those events is useful, inconjunction with other financial statement informa-tion, to investors, creditors, and other users as an aidin assessing factors such as the entity’s financial flex-ibility, profitability, and risk.

57. Transactions with owners are now normally rec-ognized when they occur. Recognition problems con-cerning them can be difficult; for example, problemssometimes arise in distinguishing transactions withowners from transactions with certain creditors, andinvestments and dividends in kind may present meas-urement problems.37 However, the recognition im-plications of earnings that lead to special guidance donot apply to transactions with owners, and that sort ofspecial guidance is not needed for them.

RECOGNITION CRITERIA

58. As noted in paragraphs 6–9, recognition is theprocess of formally recording or incorporating anitem into the financial statements of an entity as anasset, liability, revenue, expense, or the like. A recog-nized item is depicted in both words and numbers,with the amount included in the statement totals.

Recognition comprehends both initial recognition ofan item and recognition of subsequent changes in orremoval of a previously recognized item.

Purposes of Criteria

59. Criteria are set forth in this Statement to providedirection for resolving issues that involve accountingrecognition. An entity’s assets and liabilities and theeffects of events on them and on its equity are candi-dates for recognition in its financial statements.

60. Some events that affect assets, liabilities, or eq-uity are not recognized in financial statements at thetime they occur. Some events that result in futurebenefits, for example, creation of product awarenessby advertising and promotion, may perhaps never berecognized as separate assets. Other events, for ex-ample, a disaster loss of unknown dimension, are rec-ognized only when sufficient information about theeffects of the event has become available at a justifi-able cost to reduce uncertainty to an acceptable level.Recognition criteria aid in making those determina-tions.

Structure of Recognition Criteria

61. The recognition criteria in this Statement are de-rived from the qualitative characteristics of financialinformation in Concepts Statement 2 and are helpfulin making the definitions of elements of financialstatements in Concepts Statement 3 operational in re-solving financial reporting issues.

62. The fundamental criteria apply to all recognitiondecisions. Further guidance is provided in para-graphs 78–87 for applying the fundamental criteria tocomponents of earnings.

Fundamental Recognition Criteria

63. An item and information about it should meetfour fundamental recognition criteria to be recog-nized and should be recognized when the criteria are

35Rather than as its employees, suppliers, customers, lenders, or the like (Concepts Statement 3, par. 44); that Statement defines investments byand distributions to owners in paragraphs 52–55.36Capital transactions are transactions with owners that affect ownership interests (equity) in an entity:

Although capital is not a precise term in referring to ownership interests because it is also applied to assets and liabilities invarious ways, it is used in this discussion because capital is part of so many terms commonly used to describe aspects ofownership interests; for example, investments by owners are commonly called capital contributions, distributions to ownersare commonly called capital distributions, and discussions of comprehensive income and its components often refer to capi-tal maintenance. [Concepts Statement 3, par. 144]

37Concepts Statement 3, par. 49, and APB Opinion No. 29, Accounting for Nonmonetary Transactions.


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met, subject to a cost-benefit constraint and a materi-ality threshold. Those criteria are:

Definitions—The item meets the definition of anelement of financial statements.

Measurability—It has a relevant attribute meas-urable with sufficient reliability.

Relevance—The information about it is capableof making a difference in user decisions.

Reliability—The information is representation-ally faithful, verifiable, and neutral.

All four criteria are subject to a pervasive cost-benefitconstraint: the expected benefits from recognizing aparticular item should justify perceived costs of pro-viding and using the information.38 Recognition isalso subject to a materiality threshold: an item and in-formation about it need not be recognized in a set offinancial statements if the item is not large enough tobe material and the aggregate of individually imma-terial items is not large enough to be material to thosefinancial statements.39

Definitions

64. The definitions are those in FASB ConceptsStatement No. 3, Elements of Financial Statements ofBusiness Enterprises.40 To be recognized in financialstatements, a resource must meet the definition of anasset, and an obligation must meet the definition of aliability. A change in equity must meet the definitionof a revenue, expense, gain, or loss to be recognizedas a component of comprehensive income.41

Measurability

65. The asset, liability, or change in equity musthave a relevant attribute42 that can be quantified inmonetary units with sufficient reliability. Measurabil-ity must be considered together with both relevanceand reliability.

Measurement attributes

66. Items currently reported in financial statementsare measured by different attributes, depending onthe nature of the item and the relevance and reliabil-ity of the attribute measured. The Board expects theuse of different attributes to continue.

67. Five different attributes of assets (and liabilities)are used in present practice:

a. Historical cost (historical proceeds). Property,plant, and equipment and most inventories are re-ported at their historical cost, which is the amountof cash, or its equivalent, paid to acquire an asset,commonly adjusted after acquisition for amortiza-tion or other allocations. Liabilities that involveobligations to provide goods or services to cus-tomers are generally reported at historical pro-ceeds, which is the amount of cash, or its equiva-lent, received when the obligation was incurredand may be adjusted after acquisition for amorti-zation or other allocations.

b. Current cost. Some inventories are reported attheir current (replacement) cost, which is theamount of cash, or its equivalent, that would haveto be paid if the same or an equivalent asset wereacquired currently.

38Concepts Statement 2, pars. 32 and 33 and 133–144.39“Individual judgments are required to assess materiality. . . . The essence of the materiality concept is clear. The omission or misstatement of anitem in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that thejudgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item”(Concepts Statement 2, par. 132).40Concepts Statement 3 does not define elements of cash flow statements but notes classes of items that may be called elements of financialstatements, for example, cash provided by operations, cash provided by borrowing, cash provided by issuing equity securities, and so forth (par.4). However, all items in cash flow statements involve cash receipts or payments, which for recognition purposes are covered by the definitions inthat Statement.41As already noted (pars. 42 and 43), the items called cumulative accounting adjustments and other nonowner changes in equity are gains andlosses under the definitions in Concepts Statement 3.42Attribute “refers to the traits or aspects of an element to be quantified or measured, such as historical cost/historical proceeds, currentcost/current proceeds, etc.Attribute is a narrower concept than measurement, which includes not only identifying the attribute to be measured butalso selecting a scale of measurement (for example, units of money or units of constant purchasing power)” (Concepts Statement 1, par. 2, foot-note 2).


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c. Current market value. Some investments in mar-ketable securities are reported at their current mar-ket value, which is the amount of cash, or itsequivalent, that could be obtained by selling an as-set in orderly liquidation. Current market value isalso generally used for assets expected to be soldat prices lower than previous carrying amounts.Some liabilities that involve marketable com-modities and securities, for example, the obliga-tions of writers of options or sellers of commonshares who do not own the underlying commodi-ties or securities, are reported at current marketvalue.

d. Net realizable (settlement) value. Short-term re-ceivables and some inventories are reported attheir net realizable value, which is the nondis-counted amount of cash, or its equivalent, intowhich an asset is expected to be converted in duecourse of business less direct costs, if any, neces-sary to make that conversion. Liabilities that in-volve known or estimated amounts of money pay-able at unknown future dates, for example, tradepayables or warranty obligations, generally are re-ported at their net settlement value, which is thenondiscounted amounts of cash, or its equivalent,expected to be paid to liquidate an obligation inthe due course of business, including direct costs,if any, necessary to make that payment.

e. Present (or discounted) value of future cash flows.Long-term receivables are reported at theirpresent value (discounted at the implicit or histori-cal rate), which is the present or discounted valueof future cash inflows into which an asset is ex-pected to be converted in due course of businessless present values of cash outflows necessary toobtain those inflows. Long-term payables aresimilarly reported at their present value (dis-counted at the implicit or historical rate), which isthe present or discounted value of future cash out-flows expected to be required to satisfy the liabil-ity in due course of business.

68. The different attributes often have the sameamounts, particularly at initial recognition. As a re-sult, there may be agreement about the appropriateamount for an item but disagreement about the at-tribute being used. Present financial statements fre-quently are characterized as being based on the his-torical cost (historical proceeds) attribute. That nodoubt reflects the fact that, for most enterprises, a

great many of the individual events recognized in fi-nancial statements are acquisitions of goods or serv-ices for cash or equivalent that are recorded at histori-cal cost. Although the “historical cost system”description may be convenient and describes wellpresent practice for some major classes of assets(most inventories, property, plant, and equipment,and intangibles), it describes less well present prac-tice for a number of other classes of assets andliabilities—for example, trade receivables, notes pay-able, and warranty obligations.

69. “Historical exchange price” is more descriptiveof the quantity most generally reflected in financialstatements in present practice (and “transaction-based system” would be a better description of thepresent accounting model than “historical cost sys-tem”). Amounts initially recorded for trade receiv-ables and long-term notes payable, for example, gen-erally fit the historical exchange price description.But some assets are acquired, and some liabilities areincurred, without exchanges—for example, assetsfound or received as contributions and income tax orlitigation liabilities. There is no historical exchangeprice in those situations, and some other attributemust be used. Moreover, carrying amounts of assets(liabilities) are frequently reduced (increased) fromhistorical exchange price to a lower (higher) currentcost, current market value, or net realizable value,even though no subsequent exchange of the assetsheld or liabilities owed has occurred. And some as-sets are carried at current market value, independentof historical exchange price.

70. Rather than attempt to characterize present prac-tice as being based on a single attribute with numer-ous major exceptions for diverse reasons, this con-cepts Statement characterizes present practice asbased on different attributes. Rather than attempt toselect a single attribute and force changes in practiceso that all classes of assets and liabilities use that at-tribute, this concepts Statement suggests that use ofdifferent attributes will continue, and discusses howthe Board may select the appropriate attribute in par-ticular cases.43

Monetary unit or measurement scale

71. The monetary unit or measurement scale in fi-nancial statements in current practice is nominal units

43This discussion of measurement attributes is based in part on the FASB Discussion Memorandum, Conceptual Framework for Financial Ac-counting and Reporting: Elements of Financial Statements and Their Measurement (December 2, 1976), paragraphs 388–574, which furtherdescribes and illustrates each of the attributes and remains a useful reference.


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of money, that is, unadjusted for changes in purchas-ing power of money over time. An ideal measure-ment scale would be one that is stable over time. Atlow rates of change in general purchasing power (in-flation or deflation), nominal units of money are rela-tively stable. Also, preparation and use of financialstatements is simpler with nominal units than withother units of measure, such as units of constant gen-eral purchasing power (used, for example, in supple-mentary disclosures of the effects of changingprices),44 artificial monetary units (for example, theEuropean Currency Unit or ECU), or units of a com-modity (for example, ounces of gold). However, asrates of change in general purchasing power increase,financial statements expressed in nominal units ofmoney become progressively less useful and lesscomparable.

72. The Board expects that nominal units of moneywill continue to be used to measure items recognizedin financial statements. However, a change frompresent circumstances (for example, an increase ininflation to a level at which distortions became intol-erable) might lead the Board to select another, morestable measurement scale.

Relevance

73. Relevance is a primary qualitative characteristic.To be relevant, information about an item must havefeedback value or predictive value (or both) for usersand must be timely.45 Information is relevant if it hasthe capacity to make a difference in investors’, credi-tors’, or other users’ decisions. To be recognized, theinformation conveyed by including an asset, liability,or change therein in the financial statements must berelevant.

74. The relevance of particular information about anitem being considered for recognition cannot be de-termined in isolation. Relevance should be evaluatedin the context of the principal objective of financialreporting: providing information that is useful inmaking rational investment, credit, and similar deci-sions.46 Relevance should also be evaluated in thecontext of the full set of financial statements—withconsideration of how recognition of a particular itemcontributes to the aggregate decision usefulness.

Reliability

75. Reliability is the other primary qualitative char-acteristic. To be reliable, information about an itemmust be representationally faithful, verifiable, andneutral.47 To be reliable, information must be suffi-ciently faithful in its representation of the underlyingresource, obligation, or effect of events and suffi-ciently free of error and bias to be useful to investors,creditors, and others in making decisions. To be rec-ognized, information about the existence and amountof an asset, liability, or change therein must bereliable.

76. Reliability may affect the timing of recognition.The first available information about an event thatmay have resulted in an asset, liability, or changetherein is sometimes too uncertain to be recognized:it may not yet be clear whether the effects of theevent meet one or more of the definitions or whetherthey are measurable, and the cost of resolving thoseuncertainties may be excessive. Information aboutsome items that meet a definition may never becomesufficiently reliable at a justifiable cost to recognizethe item. For other items, those uncertainties are re-duced as time passes, and reliability is increased asadditional information becomes available.

77. Unavailability or unreliability of informationmay delay recognition of an item, but waiting for vir-tually complete reliability or minimum cost maymake the information so untimely that it loses its rel-evance. At some intermediate point, uncertainty maybe reduced at a justifiable cost to a level tolerable inview of the perceived relevance of the information. Ifother criteria are also met, that is the appropriatepoint for recognition. Thus, recognition may some-times involve a trade-off between relevance andreliability.

GUIDANCE IN APPLYING CRITERIATOCOMPONENTS OF EARNINGS

78. This section discusses the need for and providesfurther guidance in applying the fundamental criteriain recognizing components of earnings. Changes innet assets are recognized as components of earnings

44FASB Statement No. 33, Financial Reporting and Changing Prices, as amended.45Concepts Statement 2, pars. 46–57.46Concepts Statement 1, pars. 34–40.47Concepts Statement 2, pars. 58–110.


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if they qualify under the guidance in para-graphs 83–87. Certain changes in net assets (dis-cussed in paragraphs 42–44 and 49–51) that meet thefour fundamental recognition criteria just describedmay qualify for recognition in comprehensive in-come even though they do not qualify for recognitionas components of earnings based on that guidance.

79. Further guidance in applying the recognition cri-teria to components of earnings is necessary becauseof the widely acknowledged importance of informa-tion about earnings and its components as a primarymeasure of performance for a period. The perform-ance measured is that of the entity, not necessarilythat of its management, and includes the recognizedeffects upon the entity of events and circumstancesboth within and beyond the control of the entity andits management.48 The widely acknowledged impor-tance of earnings information leads to guidance in-tended in part to provide more stringent requirementsfor recognizing components of earnings than for rec-ognizing other changes in assets or liabilities.

80. As noted in paragraph 36, earnings measures theextent to which asset inflows (revenues and gains) as-sociated with substantially completed cash-to-cashcycles exceed asset outflows (expenses and losses)associated, directly or indirectly, with the samecycles. Guidance for recognizing components ofearnings is concerned with identifying which cyclesare substantially complete and with associating par-ticular revenues, gains, expenses, and losses withthose cycles.

81. In assessing the prospect that as yet uncompletedtransactions will be concluded successfully, a degreeof skepticism is often warranted.49 Moreover, as a re-action to uncertainty, more stringent requirementshistorically have been imposed for recognizing rev-enues and gains than for recognizing expenses andlosses, and those conservative reactions influence the

guidance for applying the recognition criteria to com-ponents of earnings.

82. The guidance stated here is intended to summa-rize key considerations in a form useful for guidancefor future standard setting—guidance which also isconsistent with the vast bulk of current practice. Thefollowing paragraphs provide guidance separatelyfor recognition of revenues and gains and for ex-penses and losses as components of earnings.

Revenues and Gains

83. Further guidance for recognition of revenues andgains is intended to provide an acceptable level of as-surance of the existence and amounts of revenuesand gains before they are recognized. Revenues andgains of an enterprise during a period are generallymeasured by the exchange values of the assets(goods or services) or liabilities involved, and recog-nition involves consideration of two factors, (a) beingrealized or realizable and (b) being earned, withsometimes one and sometimes the other being themore important consideration.

a. Realized or realizable. Revenues and gains gener-ally are not recognized until realized or realiz-able.50 Revenues and gains are realized whenproducts (goods or services), merchandise, orother assets are exchanged for cash or claims tocash. Revenues and gains are realizable when re-lated assets received or held are readily convert-ible to known amounts of cash or claims to cash.Readily convertible assets have (i) interchange-able (fungible) units and (ii) quoted prices avail-able in an active market that can rapidly absorbthe quantity held by the entity without signifi-cantly affecting the price.

b. Earned. Revenues are not recognized untilearned. An entity’s revenue-earning activities in-volve delivering or producing goods, renderingservices, or other activities that constitute its on-

48“What happens to a business enterprise is usually so much a joint result of a complex interaction of many factors that neither accounting norother statistical analysis can discern with reasonable accuracy the degree to which management, or any other factor, affected the joint result”(Concepts Statement 1, par. 53).49Concepts Statement 2, par. 97.50The terms realized and realizable are used in the Board’s conceptual framework in precise senses, focusing on conversion or convertibility ofnoncash assets into cash or claims to cash (Concepts Statement 3, par. 83). Realized has sometimes been used in a different, broader sense: forexample, some have used that term to include realizable or to include certain conversions of noncash assets into other assets that are also not cashor claims to cash. APB Statement 4, paragraphs 148–153, used the term realization even more broadly as a synonym for recognition.


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going major or central operations,51 and revenuesare considered to have been earned when the en-tity has substantially accomplished what it mustdo to be entitled to the benefits represented by therevenues. Gains commonly result from transac-tions and other events that involve no “earningprocess,” and for recognizing gains, being earnedis generally less significant than being realized orrealizable.

84. In recognizing revenues and gains:

a. The two conditions (being realized or realizableand being earned) are usually met by the timeproduct or merchandise is delivered or servicesare rendered to customers, and revenues frommanufacturing and selling activities and gains andlosses from sales of other assets are common-ly recognized at time of sale (usually meaningdelivery).52

b. If sale or cash receipt (or both) precedes produc-tion and delivery (for example, magazine sub-scriptions), revenues may be recognized as earnedby production and delivery.

c. If product is contracted for before production, rev-enues may be recognized by a percentage-of-completion method as earned—as productiontakes place—provided reasonable estimates of re-sults at completion and reliable measures ofprogress are available.53

d. If services are rendered or rights to use assets ex-tend continuously over time (for example, interestor rent), reliable measures based on contractualprices established in advance are commonly avail-able, and revenues may be recognized as earnedas time passes.

e. If products or other assets are readily realizablebecause they are salable at reliably determinableprices without significant effort (for example, cer-tain agricultural products, precious metals, andmarketable securities), revenues and some gainsor losses may be recognized at completion of pro-

duction or when prices of the assets change. Para-graph 83(a) describes readily realizable (convert-ible) assets.

f. If product, services, or other assets are exchangedfor nonmonetary assets that are not readily con-vertible into cash, revenues or gains or losses maybe recognized on the basis that they have beenearned and the transaction is completed. Gains orlosses may also be recognized if nonmonetary as-sets are received or distributed in nonreciprocaltransactions. Recognition in both kinds of transac-tions depends on the provision that the fair valuesinvolved can be determined within reasonablelimits.54

g. If collectibility of assets received for product,services, or other assets is doubtful, revenues andgains may be recognized on the basis of cash re-ceived.

Expenses and Losses

85. Further guidance for recognition of expenses andlosses is intended to recognize consumption (usingup) of economic benefits or occurrence or discoveryof loss of future economic benefits during a period.Expenses and losses are generally recognized whenan entity’s economic benefits are used up in deliver-ing or producing goods, rendering services, or otheractivities that constitute its ongoing major or centraloperations or when previously recognized assets areexpected to provide reduced or no further benefits.

Consumption of Benefits

86. Consumption of economic benefits during a pe-riod may be recognized either directly or by relatingit to revenues recognized during the period:55

a. Some expenses, such as cost of goods sold, arematched with revenues—they are recognizedupon recognition of revenues that result directly

51“Most types of revenue are the joint result of many profit-directed activities of an enterprise and revenue is often described as being ‘earned’gradually and continuously by the whole of enterprise activities. Earning in this sense is a technical term that refers to the activities that give riseto the revenue—purchasing, manufacturing, selling, rendering service, delivering goods, allowing other entities to use enterprise assets, the oc-currence of an event specified in a contract, and so forth. All of the profit-directed activities of an enterprise that comprise the process by whichrevenue is earned may be called the earning process” (APB Statement 4, par. 149). Concepts Statement 3, paragraph 64, footnote 31, contains thesame concept.52The requirement that revenue be earned before it is recorded “usually causes no problems because the earning process is usually complete ornearly complete by the time of [sale]” (APB Statement 4, par. 153).53If production is long in relation to reporting periods, such as for long-term, construction-type contracts, recognizing revenues as earned hasoften been deemed to result in information that is significantly more relevant and representationally faithful than information based on waitingfor delivery, although at the sacrifice of some verifiability. (Concepts Statement 2, paragraphs 42–45, describes trade-offs of that kind.)54APB Opinion 29.55Concepts Statement 3, pars. 84–89.


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and jointly from the same transactions or otherevents as the expenses.

b. Many expenses, such as selling and administra-tive salaries, are recognized during the period inwhich cash is spent or liabilities are incurred forgoods and services that are used up either simulta-neously with acquisition or soon after.

c. Some expenses, such as depreciation and insur-ance, are allocated by systematic and rational pro-cedures to the periods during which the related as-sets are expected to provide benefits.

Loss or Lack of Future Benefit

87. An expense or loss is recognized if it becomesevident that previously recognized future economicbenefits of an asset have been reduced or eliminated,or that a liability has been incurred or increased,without associated economic benefits.

RECOGNITION OF CHANGES IN ASSETSAND LIABILITIES

88. Initial recognition of assets acquired and liabili-ties incurred generally involves measurement basedon current exchange prices at the date of recognition.Once an asset or a liability is recognized, it continuesto be measured at the amount initially recognized un-til an event that changes the asset or liability or itsamount occurs and meets the recognition criteria.

89. Events that change assets and liabilities are oftwo types: (a) inflows (acquisitions of assets or incur-rences of liabilities) and outflows (sale or other dis-posal or loss of assets and settlement or cancellationof liabilities) and (b) changes of amounts of assetswhile held or of liabilities while owed by the entity.The latter also are of two types: (i) changes in utilityor substance and (ii) changes in price. Examples ofchanges in utility or substance that are recognized incurrent practice include use of assets in production,depreciation of assets used in administrative activi-ties, and fire damage to assets.

90. Information based on current prices should berecognized if it is sufficiently relevant and reliable tojustify the costs involved and more relevant than al-ternative information. The merits of recognizingchanges in prices may be clear in certain cases, and,as already noted, some price changes are recognizedin present practice. In other cases, the relative meritsof information based on current prices and alternativeinformation may be unclear or may be a matter of

dispute. In considering the application of the funda-mental recognition criteria, those relative merits mustbe evaluated in the light of the circumstances ofeach case.

SUMMARY

91. Most aspects of current practice are consistentwith the recognition criteria and guidance in thisStatement, but the criteria and guidance do not fore-close the possibility of future changes in practice.This Statement is intended to provide guidance fororderly change in accounting standards whenneeded. When evidence indicates that informationabout an item that is more useful (relevant and reli-able) than information currently reported is availableat a justifiable cost, it should be included in financialstatements.

This Statement was adopted by the affırmativevote of six members of the Financial AccountingStandards Board. Mr. March dissented.

Mr. March dissents from this Statement because(a) it does not adopt measurement concepts orientedtoward what he believes is the most useful single at-tribute for recognition purposes, the cash equivalentof recognized transactions reduced by subsequentimpairments or loss of service value—instead it sug-gests selecting from several different attributes with-out providing sufficient guidance for the selectionprocess; (b) it identifies all nonowner changes in as-sets and liabilities as comprehensive income and re-turn on equity, thereby including in income, incor-rectly in his view, capital inputs from nonowners,unrealized gains from price changes, amounts thatshould be deducted to maintain capital in real terms,and foreign currency translation adjustments; (c) ituses a concept of income that is fundamentally basedon measurements of assets, liabilities, and changes inthem, rather than adopting the Statement’s concept ofearnings as the definition of income; and (d) it fails toprovide sufficient guidance for initial recognition andderecognition of assets and liabilities.

Mr. March would not, in general, recognize in-creases in prices of assets and decreases in prices ofliabilities before they are realized. He believespresent measurement practice can be characterized aslargely using a single attribute, the cash equivalent ofrecognized transactions reduced by subsequent im-pairments or loss of service value, and that presentpractices that recognize revenues or gains fromchanges in prices before realization, such as the usesof current market values and net realizable values


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cited in paragraphs 67(c) and (d) and 69, are excep-tions to the general use of that single attribute. Mr.March is concerned that the guidance in para-graph 90 would permit, and perhaps point toward,more recognition of changes in current prices beforerealization. He believes that income, recognition, andmeasurement concepts based largely on the single at-tribute that he proposes are most relevant to reportingcapital committed, performance, and the investmentand realization of resources.

Mr. March objects to comprehensive income, de-fined in Concepts Statement 3 and confirmed in thisStatement, as a concept of income because it includesall recognized changes (including price changes) inassets and liabilities other than investments by own-ers and distributions to owners. He would excludefrom income, and include in the amount of capital tobe maintained (in addition to transactions with own-ers), what he would consider to be direct capital in-puts to the enterprise from nonowner sources. Thoseinclude governmental and other capital contributionsor grants and capital arising in reorganizations, re-capitalizations, and extinguishments or restatementsof debt capital.

Mr. March would also require that income mustfirst deduct a provision for maintenance of capital inreal terms (adjusted for changes in purchasing powerof money over time, paragraphs 71–72). He believesthat is necessary to avoid reporting a return of capitalas income. Complex implementation should not benecessary to provide for the erosion of capital caused

by the effects of inflation on the unit of measure. A“rubber yardstick” is a poor measuring tool. Mr.March would also exclude from income foreign cur-rency translation adjustments (excluded from earn-ings but included in comprehensive income by para-graph 42(b)), which he believes are analogous toprovisions for maintenance of capital in real terms.

The description of earnings (paragraphs 33–38)and the guidance for applying recognition criteria tocomponents of earnings (paragraphs 78–87) is con-sistent with Mr. March’s view that income shouldmeasure performance and that performance flowsprimarily from an entity’s fulfillment of the terms ofits transactions with outside entities that result in rev-enues, other proceeds on resource dispositions(gains), costs (expenses) associated with those rev-enues and proceeds, and losses sustained. However,Mr. March believes that those concepts are funda-mental and should be embodied in definitions of theelements of financial statements and in basic incomerecognition criteria rather than basing income onmeasurements of assets, liabilities, and changesin them.

Disregarding the foregoing objections, Mr. Marchbelieves this Statement offers insufficient guidancefor the near-term future work of the Board. To beuseful, it needs to be supplemented with more spe-cific guidance for selecting measurement attributesfor specific assets, liabilities, and transactions and fordeciding when the criteria require recognition orderecognition of an asset or a liability.

Members of the Financial Accounting Standards Board:

Donald J. Kirk,Chairman

Frank E. Block

Victor H. BrownRaymond C. LauverJohn. W. March

David MossoRobert T. Sprouse

Appendix

BACKGROUND INFORMATION

92. The Board’s study of recognition and measure-ment concepts has spanned several years. The needto develop those concepts was identified early in theconceptual framework project, and the first FASBConcepts Statement, Objectives of Financial Report-ing by Business Enterprises, listed them among sev-eral separate matters to be covered:

. . . Later Statements are expected to coverthe elements of financial statements and theirrecognition, measurement, and display . . . ,criteria for distinguishing information to beincluded in financial statements from thatwhich should be provided by other means offinancial reporting, and criteria for evaluatingand selecting accounting information (quali-tative characteristics). [paragraph 2]


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93. During that period, three FASB Research Re-ports,56 a Discussion Memorandum,57 a conceptsStatement,58 and an Exposure Draft59 have dealt inwhole or in part with recognition and measurementmatters, and the Board has discussed those mattersextensively.

94. The once-separate projects on recognition andon measurement were combined, principally becausein the Board’s view certain recognition questions,which are among the most important to be dealt with,are so closely related to measurement issues that it isnot productive to discuss them separately. For ex-ample, the question of whether the appropriate at-tribute to measure a particular item is a past exchangeprice or a current exchange price is not easily sepa-rable from the question of whether events such asprice changes should be recognized.

95. The Board issued an Exposure Draft, Recogni-tion and Measurement in Financial Statements ofBusiness Enterprises, on December 30, 1983 and re-ceived 104 letters of comment on it.

96. The changes made to the Exposure Draft werelargely in response to suggestions in those commentletters and are intended to improve the clarity and or-ganization of the ideas presented in the ExposureDraft. The Board believes that the substance of thisStatement is not significantly changed from the Ex-posure Draft. Noteworthy changes made andchanges suggested but not made are discussed below.

97. The discussion of financial statements, financialreporting, and recognition in paragraphs 5–12 hasbeen expanded and reorganized in response to com-ments that the status of notes, supplementary infor-mation, and other means of financial reporting out-side of financial statements (all of which are outsidethe scope of this concepts Statement) was unclear.

98. The term full set of financial statements has beenused in paragraph 13 and elsewhere in response tocomments that complete set, the term used in the Ex-

posure Draft, implied that no further information be-yond the listed financial statements was needed andto comments that complete set had been used in somestandards in a different way.

99. A number of respondents inferred from the dis-cussion of cash flow statements in the ExposureDraft that the Board had decided one or more specificissues about cash flow reporting. Those issues in-clude the direct and indirect methods of presentation;whether or not “cash” should include equivalents tocash and, if so, what instruments qualify; whether ornot the nonmonetary transactions currently reportedin statements of changes in financial position shouldappear in cash flow statements; and the definitions ofcash provided by (or used for) operations, financingactivities, and investing activities. Those and otherspecific cash flow statement issues mentioned by re-spondents are beyond the scope of this conceptsStatement. The discussion of the statement of cashflows was revised to emphasize that.

100. Many respondents criticized the term compre-hensive income and some criticized the term earn-ings as unwarranted innovations likely to cause con-fusion and legal difficulties. Those terms are not new.They were first used in their present senses in Con-cepts Statement 3, in which the Board defined com-prehensive income as an element of financial state-ments and reserved the term earnings for possiblelater use to designate a component part of compre-hensive income. This Statement carries forward theconcept of comprehensive income and describes aconcept for earnings. The Board retained the idea oftwo separate measures both to reflect present practicefor the items discussed in paragraph 42(b) and to al-low for the possibility that future standards may rec-ognize some items, for example, the cumulative ac-counting adjustments discussed in paragraph 42(a),in comprehensive income but not in earnings.

101. The Board explored the alternative terms forcomprehensive income and earnings suggested by re-spondents, as well as other possibilities suggested by

56Recognition of Contractual Rights and Obligations: An Exploratory Study of Conceptual Issues, by Yuji Ijiri, December 1980; Survey ofPresent Practices in Recognizing Revenues, Expenses, Gains, and Losses, by Henry R. Jaenicke, January 1981; and Recognition in FinancialStatements: Underlying Concepts and Practical Conventions, by L. Todd Johnson and Reed K. Storey, July 1982.57FASB Discussion Memorandum, Conceptual Framework for Financial Accounting and Reporting: Elements of Financial Statements andTheir Measurement, December 2, 1976, Part III.58FASB Concepts Statement No. 3, Elements of Financial Statements of Business Enterprises, pars. 16 and 17, 37–43, and 74–89.59FASB Exposure Draft, Reporting Income, Cash Flows, and Financial Position of Business Enterprises, November 1981, pars. 13–16 andelsewhere. This Statement supersedes that Exposure Draft.


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its staff, but concluded that the other terms had disad-vantages greater than those attaching to the termsoriginally selected. The Statement was revised to in-dicate that the Board anticipates that, as with net in-come in present practice, a variety of terms will beused in future financial statements as names for earn-ings (for example, net income, profit, or net loss) andfor comprehensive income (for example, total non-owner changes in equity or comprehensive loss).

102. Some respondents urged the Board to clarifythe concept of earnings. The discussion in para-graphs 36–38, the table in paragraph 44, and footnote26 have been rewritten to explain more fully what theBoard intended.

103. The materiality threshold for recognition, im-plicit in the conceptual framework, has been madeexplicit in paragraph 63 at the suggestion of severalrespondents. Some respondents suggested that mate-riality and cost–benefit considerations should be fun-damental recognition criteria. No change was madebecause the Board believes that, while those consid-erations affect the application of the criteria, they aredifferent in character from the four fundamental rec-ognition criteria.

104. Several respondents urged the Board to includethe question of the monetary unit or measurementscale within the scope of the Statement. The Expo-sure Draft described present practice as using nomi-nal units of money but left the unit of measure out-side its scope. The Board clarified the matter byindicating in paragraph 72 that it expects that nomi-nal units of money will continue to be used to meas-ure items recognized in financial statements.

105. The discussion of measurement has been ex-panded, in response to the suggestions of several re-spondents, to explain and illustrate the different at-tributes more fully and to discuss why differentattributes are needed to describe present practice andare expected to continue to be used to measure itemsin financial statements.

106. Some respondents expressed concern that theguidance in paragraph 84(e) (concerning circum-stances under which revenue or gain may be recog-nized at completion of production or when prices ofassets change) and the guidance in paragraph 87(concerning recognition of losses when it becomesevident that assets have been reduced or eliminatedor liabilities incurred or increased without associatedbenefits) meant significant change from present prac-tice. Those paragraphs describe concepts that theBoard believes underlie many current practices andstandards, just as do the other parts of the guidancefor recognition of components of earnings. Theyhave been retained and clarified.

107. Several respondents urged the Board to addressin this Statement certain specific recognition andmeasurement issues including definitive guidance forrecognition of contracts that are fully executory (thatis, contracts as to which neither party has as yet car-ried out any part of its obligations, which are gener-ally not recognized in present practice) and selectionof measurement attributes for particular assets and li-abilities. Those issues have long been, and remain,unresolved on a general basis. As noted in the intro-ductory statement to this and earlier concepts State-ments (page CON5−4), establishment of objectivesand identification of fundamental concepts will notdirectly solve specific financial accounting and re-porting problems. Rather, objectives give direction,and concepts are tools for solving problems.

108. The Board and others who use this Statementwill be guided and aided by the concepts it sets forth,but judgments, based on the particular circumstancesof each case, will continue to play a major role insolving problems of recognition and measurement infinancial statements. The Board believes that furtherdevelopment of recognition, measurement, and dis-play matters will occur as the concepts are applied atthe standards level.


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Summary Index of Concepts Defined or Discussed

ParagraphNumbers

Articulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5, 12, 23, 45Attributes measured . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .66–70, footnote 42, 105, 107Capital maintenance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45–48Cash flow, statement of. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 52–54, 99Comprehensive income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 30–32, 39–44, 100–101Consumption of benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .86Cumulative accounting adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42–44, 100Current market value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67, 69Current prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .90Current (replacement) cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67, 69Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63–64Distributions to owners, statement of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 55–57Earned. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83–84Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 30–38, 42–44, 49–51, 100–102Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85–87Financial flexibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24, footnote 13Financial position, statement of . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 26–30Financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5–57, 97Full set of financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 98Gains . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83–84Guidance for components of earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78–87, 106Historical cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67–69Investments by owners, statement of. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13, 24, 55–57Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24, footnote 13Losses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85–87, 106Loss of benefit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87Measurability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63, 65–72Net realizable (settlement) value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67Notes to financial statements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7–9, footnote 4, 97Other means of financial reporting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7–9, 92, 97Other nonowner changes in equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42–44, footnote 27Present value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67Realized and realizable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83–84, footnote 50Recognition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6–7, 58, 94, 97, 108Recognition criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63, 103Relevance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63, 73–74Reliability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63, 75–77Revenues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83–84Supplementary information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7–9, 97Unit of measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71–72, 104


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Education

FASB Concept stmt 5