The Conceptual Framework for Financial Reporting explains the principles of recognition and derecognition of items in financial statements. Recognition determines whether an item should be included in the financial statements, while derecognition deals with the removal of a previously recognized asset or liability from the statement of financial position.
Recognition of Elements of Financial Statements
Recognition refers to including an item in the financial statements. An item can be recognized only when it meets the definition of one of the elements of financial statements, namely an asset, liability, equity, income, or expense.
Therefore, an item that does not meet the definition of any of these elements cannot be recognized in the financial statements. Meeting the definition of an element is the basic requirement for recognition.
Recognition is considered appropriate when it results in financial information that possesses the qualities of relevance and faithful representation.
Relevance in Recognition
For an item to be recognized, the resulting financial information should be relevant to users of financial statements. Relevant information is information that is useful to users and is capable of helping them in making financial and economic decisions.
Therefore, recognition of an asset, liability, equity, income, or expense should provide information that improves the usefulness of the financial statements.
Faithful Representation in Recognition
Recognition should also result in a faithful representation of the item being reported. The item should be capable of being measured with a level of measurement uncertainty that does not prevent the information from being useful.
Some degree of measurement uncertainty may exist while determining the amount of an item. However, such uncertainty should not be so high that the financial information becomes unsuitable or ineffective for users.
Thus, an item may be recognized when its measurement provides sufficiently useful information and faithfully represents the economic matter being reported.
Derecognition
Derecognition means the removal of all or part of a previously recognized asset or liability from an entity’s statement of financial position.
Derecognition may relate to the complete removal of an asset or liability or the removal of only a part of it. Therefore, derecognition is the opposite of recognition in the sense that a recognized item, either fully or partly, is removed from the statement of financial position.
Key Points
An item is recognized in financial statements only when it meets the definition of an asset, liability, equity, income, or expense.
Recognition is appropriate when the resulting financial information provides relevant information and faithful representation.
For faithful representation, measurement uncertainty should not be so high that it prevents the financial information from being useful.
Derecognition means the removal of all or part of a recognized asset or liability from the statement of financial position.