FASB Conceptual Framework

Statement of Financial Accounting

Concepts No. 5

Recognition and Measurement in Financial Statements of Business Enterprises

As Amended

December 2021

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STATEMENTS OF FINANCIAL ACCOUNTING CONCEPTS

This Statement of Financial Accounting Concepts is one of a series of publications

in the Board’s conceptual framework for financial accounting and reporting. Statements

in the series are intended to set forth objectives and fundamentals that will be the basis for

development of financial accounting and reporting standards. The objectives identify the

goals and purposes of financial reporting. The fundamentals are the underlying concepts

of financial accounting—concepts that guide the selection of transactions, events, and

circumstances to be accounted for; their recognition and measurement; and the means of

summarizing and communicating them to interested parties. Concepts of that type are

fundamental in the sense that other concepts flow from them and repeated reference to

them will be necessary in establishing, interpreting, and applying accounting and reporting

standards.

The conceptual framework is a coherent system of interrelated objectives and

fundamentals that is expected to lead to consistent standards and that prescribes the

nature, function, and limits of financial accounting and reporting. It is expected to serve

the public interest by providing structure and direction to financial accounting and

reporting to facilitate the provision of evenhanded financial and related information that

helps promote the efficient allocation of scarce resources in the economy and society,

including assisting capital and other markets to function efficiently.

Establishment of objectives and identification of fundamental concepts will not

directly solve financial accounting and reporting problems. Rather, objectives give

direction, and concepts are tools for solving problems.

The Board itself is likely to be the most direct beneficiary of the guidance provided

by the Statements in this series. They will guide the Board in developing accounting and

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reporting standards by providing the Board with a common foundation and basic

reasoning on which to consider merits of alternatives.

However, knowledge of the objectives and concepts the Board will use in

developing standards also should enable those who are affected by or interested in

financial accounting standards to understand better the purposes, content, and

characteristics of information provided by financial accounting and reporting. That

knowledge is expected to enhance the usefulness of, and confidence in, financial

accounting and reporting. The concepts also may provide some guidance in analyzing

new or emerging problems of financial accounting and reporting in the absence of

applicable authoritative pronouncements.

Statements of Financial Accounting Concepts do not establish standards prescribing

accounting procedures or disclosure practices for particular items or events, which are

issued by the Board as Statements of Financial Accounting Standards. Rather, Statements

in this series describe concepts and relations that will underlie future financial accounting

standards and practices and in due course serve as a basis for evaluating existing standards

and practices.*

The Board recognizes that in certain respects current generally accepted accounting

principles may be inconsistent with those that may derive from the objectives and

concepts set forth in Statements in this series. However, a Statement of Financial

Accounting Concepts does not (a) require a change in existing generally accepted

accounting principles; (b) amend, modify, or interpret Statements of Financial Accounting

Standards, Interpretations of the FASB, Opinions of the Accounting Principles Board, or

Bulletins of the Committee on Accounting Procedure that are in effect; or (c) justify either

changing existing generally accepted accounting and reporting practices or interpreting

* Pronouncements such as APB Statement No. 4, Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises, and the Accounting Terminology Bulletins will continue to serve their intended purpose—they describe objectives and concepts underlying standards and practices existing at the time of their issuance.

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the pronouncements listed in item (b) based on personal interpretations of the objectives

and concepts in the Statements of Financial Accounting Concepts.

Since a Statement of Financial Accounting Concepts does not establish generally

accepted accounting principles or standards for the disclosure of financial information

outside of financial statements in published financial reports, it is not intended to invoke

application of Rule 203 or 204 of the Rules of Conduct of the Code of Professional Ethics

of the American Institute of Certified Public Accountants (or successor rules or

arrangements of similar scope and intent).†

Like other pronouncements of the Board, a Statement of Financial Accounting

Concepts may be amended, superseded, or withdrawn by appropriate action under the

Board’s Rules of Procedure.

† Rule 203 prohibits a member of the American Institute of Certified Public Accountants from expressing an opinion that financial statements conform with generally accepted accounting principles if those statements contain a material departure from an accounting principle promulgated by the Financial Accounting Standards Board, unless the member can demonstrate that because of unusual circumstances the financial statements otherwise would have been misleading. Rule 204 requires members of the Institute to justify departures from standards promulgated by the Financial Accounting Standards Board for the disclosure of information outside of financial statements in published financial reports.

Statement of Financial Accounting

Concepts No. 5

Recognition and Measurement in Financial Statements of Business Enterprises

As Amended

December 2021

Copyright © 2021 by Financial Accounting Foundation. All rights reserved. Content copyrighted by Financial Accounting Foundation may not be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the Financial Accounting Foundation.

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Statement of Financial Accounting Concepts No. 5

Recognition and Measurement in Financial Statements of Business Enterprises

As Amended

December 2021

CONTENTS

Paragraph Numbers

Introduction, Scope, and Limitations ....................................................................1, 3, 6, 8 Recognition Criteria ......................................................................................58–60, 63–72 Purposes of Criteria.............................................................................................59–60 Fundamental Recognition Criteria ......................................................................63–72 Definitions...........................................................................................................64 Measurability ................................................................................................65–72 Measurement Attributes ..........................................................................66–70 Monetary Unit or Measurement Scale ....................................................71–72

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HIGHLIGHTS

[Best understood in context of full Statement]

• This Statement sets forth recognition criteria and guidance on what information should be incorporated into financial statements and when.

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

• An item and information about it should meet four fundamental recognition criteria to be recognized and should 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, historical cost, current [replacement] cost, current market value, net realizable value, and present value of future cash 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 nominal units of money will continue to be used to measure items recognized in financial statements.

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Statement of Financial Accounting Concepts No. 5

Recognition and Measurement in Financial Statements of Business Enterprises

As Amended

December 2021

INTRODUCTION, SCOPE, AND LIMITATIONS

1. This Statement sets forth fundamental recognition criteria and guidance on what

information should be formally incorporated into financial statements and when. It builds

on the foundation laid by earlier concepts Statements, bringing those concepts together to

apply them to broad recognition issues.

3. This Statement also addresses certain measurement issues that are closely related to

recognition. Measurement involves choice of an attribute by which to quantify a

recognized item and choice of a scale of measurement (often called “unit of measure”).

The Statement notes that different attributes are currently used to measure different items

in financial statements and that the Board expects the use of different attributes to

continue. The Statement further notes that the measurement scale in current practice is

nominal units of money (that is, unadjusted for changes in purchasing power over time)

and that the Board expects use of nominal units to continue.

6. Recognition is the process of formally recording or incorporating an item into the

financial statements of an entity as an asset, liability, revenue, expense, or the like.

Recognition includes depiction of an item in both words and numbers, with the amount

included in the totals of the financial statements. For an asset or liability, recognition

involves recording not only acquisition or incurrence of the item but also later changes in

it, including changes that result in removal from the financial statements.

8. The scope of this concepts Statement is limited to recognition (and measurement) in

financial statements. Since recognition means depiction of an item in both words and

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numbers, with the amount included in the totals of the financial statements, disclosure by

other means is not recognition.

RECOGNITION CRITERIA

58. Recognition is the process of formally recording or incorporating an item into the

financial statements of an entity as an asset, liability, revenue, expense, or the like. A

recognized item is depicted in both words and numbers, with the amount included in the

statement totals. Recognition comprehends both initial recognition of an item and

recognition of subsequent changes in or removal of a previously recognized item.

Purposes of Criteria

59. Criteria are set forth in this Statement to provide direction for resolving issues that

involve accounting recognition. An entity’s assets and liabilities and the effects of events

on them and on its equity are candidates for recognition in its financial statements.

60. Some events that affect assets, liabilities, or equity are not recognized in financial

statements at the time they occur. Some events that result in future benefits, for example,

creation of product awareness by advertising and promotion, may perhaps never be

recognized as separate assets. Other events, for example, a disaster loss of unknown

dimension, are recognized only when sufficient information about the effects of the event

has become available at a justifiable cost to reduce uncertainty to an acceptable level.

Recognition criteria aid in making those determinations.

Fundamental Recognition Criteria

63. An item and information about it should meet four fundamental recognition criteria

to be recognized and should 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.

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Relevance–The information about it is capable of making a difference in user decisions. Reliability–The information is representationally faithful, verifiable, and neutral.

All four criteria are subject to a pervasive cost-benefit constraint: the expected benefits

from recognizing a particular item should justify perceived costs of providing and using

the information. Recognition is also subject to a materiality threshold: an item and

information about it need not be recognized in a set of financial statements if the item is

not large enough to be material and the aggregate of individually immaterial items is not

large enough to be material to those financial statements.

Definitions

64. To be recognized in financial statements, a resource must meet the definition of an

asset, and an obligation must meet the definition of a liability. A change in equity must

meet the definition of a revenue, expense, gain, or loss to be recognized as a component of

comprehensive income.

Measurability

65. The asset, liability, or change in equity must have a relevant attribute that can be

quantified in monetary units with sufficient reliability. Measurability must be considered

together with both relevance and reliability.

Measurement Attributes

66. Items currently reported in financial statements are measured by different attributes,

depending on the nature of the item and the relevance and reliability of the attribute

measured. The Board expects the use 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 reported at their historical cost, which is the amount of cash, or its equivalent, paid to acquire an asset, commonly adjusted after acquisition for amortization or other allocations. Liabilities that involve obligations to provide goods or services to customers are generally reported at historical proceeds, which is

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the amount of cash, or its equivalent, received when the obligation was incurred and may be adjusted after acquisition for amortization or other allocations.

b. Current cost. Some inventories are reported at their current (replacement) cost, which is the amount of cash, or its equivalent, that would have to be paid if the same or an equivalent asset were acquired currently.

c. Current market value. Some investments in marketable securities are reported at their current market value, which is the amount of cash, or its equivalent, that could be obtained by selling an asset in orderly liquidation. Current market value is also generally used for assets expected to be sold at prices lower than previous carrying amounts. Some liabilities that involve marketable commodities and securities, for example, the obligations of writers of options or sellers of common shares who do not own the underlying commodities or securities, are reported at current market value.

d. Net realizable (settlement) value. Short-term receivables and some inventories are reported at their net realizable value, which is the nondiscounted amount of cash, or its equivalent, into which an asset is expected to be converted in due course of business less direct costs, if any, necessary to make that conversion. Liabilities that involve known or estimated amounts of money payable at unknown future dates, for example, trade payables or warranty obligations, generally are reported at their net settlement value, which is the nondiscounted amounts of cash, or its equivalent, expected to be paid to liquidate an obligation in the 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 their present value (discounted at the implicit or historical rate), which is the present or discounted value of future cash inflows into which an asset is expected to be converted in due course of business less present values of cash outflows necessary to obtain those inflows. Long-term payables are similarly reported at their present value (discounted at the implicit or historical rate), which is the present or discounted value of future cash outflows expected to be required to satisfy the liability in due course of business.

68. The different attributes often have the same amounts, particularly at initial

recognition. As a result, there may be agreement about the appropriate amount for an item

but disagreement about the attribute being used. Present financial statements frequently

are characterized as being based on the historical cost (historical proceeds) attribute. That

no doubt reflects the fact that, for most enterprises, a great many of the individual events

recognized in financial statements are acquisitions of goods or services for cash or

equivalent that are recorded at historical cost. Although the “historical cost system”

description may be convenient and describes well present practice for some major classes

of assets (most inventories, property, plant, and equipment, and intangibles), it describes

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less well present practice for a number of other classes of assets and liabilities—for

example, trade receivables, notes payable, and warranty obligations.

69. “Historical exchange price” is more descriptive of the quantity most generally

reflected in financial statements in present practice (and “transaction-based system” would

be a better description of the present accounting model than “historical cost system”).

Amounts initially recorded for trade receivables and long-term notes payable, for

example, generally fit the historical exchange price description. But some assets are

acquired, and some liabilities are incurred, without exchanges—for example, assets found

or received as contributions and income tax or litigation liabilities. There is no historical

exchange price in those situations, and some other attribute must be used. Moreover,

carrying amounts of assets (liabilities) are frequently reduced (increased) from historical

exchange price to a lower (higher) current cost, current market value, or net realizable

value, even though no subsequent exchange of the assets held or liabilities owed has

occurred. And some assets are carried at current market value, independent of historical

exchange price.

70. Rather than attempt to characterize present practice as being based on a single

attribute with numerous major exceptions for diverse reasons, this concepts Statement

characterizes present practice as based on different attributes. Rather than attempt to

select a single attribute and force changes in practice so that all classes of assets and

liabilities use that attribute, this concepts Statement suggests that use of different attributes

will continue, and discusses how the Board may select the appropriate attribute in

particular cases.1

Monetary Unit or Measurement Scale

1This discussion of measurement attributes is based in part on the FASB Discussion Memorandum, Conceptual Framework for Financial Accounting and Reporting: Elements of Financial Statements and Their Measurement (December 2, 1976), paragraphs 388–574, which further describes and illustrates each of the attributes and remains a useful reference.

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71. The monetary unit or measurement scale in financial statements in current practice is

nominal units of money, that is, unadjusted for changes in purchasing power of money

over time. An ideal measurement scale would be one that is stable over time. At low

rates of change in general purchasing power (inflation or deflation), nominal units of

money are relatively stable. Also, preparation and use of financial statements is simpler

with nominal units than with other units of measure, such as units of constant general

purchasing power (used, for example, in supplementary disclosures of the effects of

changing prices),2 artificial monetary units (for example, the European Currency Unit or

ECU), or units of a commodity (for example, ounces of gold). However, as rates of

change in general purchasing power increase, financial statements expressed in nominal

units of money become progressively less useful and less comparable.

72. The Board expects that nominal units of money will continue to be used to measure

items recognized in financial statements. However, a change from present circumstances

(for example, an increase in inflation to a level at which distortions became intolerable)

might lead the Board to select another, more stable measurement scale.

This Statement was adopted by the affirmative vote of six members of the Financial Accounting Standards Board. Mr. March dissented.

Mr. March dissents from this Statement because (a) it does not adopt measurement

concepts oriented toward what he believes is the most useful single attribute for

recognition purposes, the cash equivalent of recognized transactions reduced by

subsequent impairments or loss of service value—instead it suggests selecting from

several different attributes without providing sufficient guidance for the selection process;

(b) it identifies all nonowner changes in assets and liabilities as comprehensive income

and return on equity, thereby including in income, incorrectly in his view, capital inputs

from nonowners, unrealized gains from price changes, amounts that should be deducted to

2FASB Statement No. 33, Financial Reporting and Changing Prices, as amended.

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maintain capital in real terms, and foreign currency translation adjustments; (c) it uses a

concept of income that is fundamentally based on measurements of assets, liabilities, and

changes in them, rather than adopting the Statement’s concept of earnings as the definition

of income; and (d) it fails to provide sufficient guidance for initial recognition and

derecognition of assets and liabilities.

Mr. March would not, in general, recognize increases in prices of assets and

decreases in prices of liabilities before they are realized. He believes present

measurement practice can be characterized as largely using a single attribute, the cash

equivalent of recognized transactions reduced by subsequent impairments or loss of

service value, and that present practices that recognize revenues or gains from changes in

prices before realization, such as the uses of current market values and net realizable

values cited in paragraphs 67(c) and (d) and 69, are exceptions to the general use of that

single attribute. Mr. March is concerned that the guidance in paragraph 90 would permit,

and perhaps point toward, more recognition of changes in current prices before

realization. He believes that income, recognition, and measurement concepts based

largely on the single attribute that he proposes are most relevant to reporting capital

committed, performance, and the investment and realization of resources.

Mr. March objects to comprehensive income, defined in Concepts Statement 3 and

confirmed in this Statement, as a concept of income because it includes all recognized

changes (including price changes) in assets and liabilities other than investments by

owners and distributions to owners. He would exclude from income, and include in the

amount of capital to be maintained (in addition to transactions with owners), what he

would consider to be direct capital inputs to the enterprise from nonowner sources. Those

include governmental and other capital contributions or grants and capital arising in

reorganizations, recapitalizations, and extinguishments or restatements of debt capital.

Mr. March would also require that income must first deduct a provision for

maintenance of capital in real terms (adjusted for changes in purchasing power of money

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over time, paragraphs 71–72). He believes that is necessary to avoid reporting a return of

capital as income. Complex implementation should not be necessary 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

currency translation adjustments (excluded from earnings but included in comprehensive

income by paragraph 42(b)), which he believes are analogous to provisions for

maintenance of capital in real terms.

The description of earnings (paragraphs 33–38) and the guidance for applying

recognition criteria to components of earnings (paragraphs 78–87) is consistent with Mr.

March’s view that income should measure performance and that performance flows

primarily from an entity’s fulfillment of the terms of its transactions with outside entities

that result in revenues, other proceeds on resource dispositions (gains), costs (expenses)

associated with those revenues and proceeds, and losses sustained. However, Mr. March

believes that those concepts are fundamental and should be embodied in definitions of the

elements of financial statements and in basic income recognition criteria rather than

basing income on measurements of assets, liabilities, and changes in them.

Disregarding the foregoing objections, Mr. March believes this Statement offers

insufficient guidance for the near-term future work of the Board. To be useful, it needs to

be supplemented with more specific guidance for selecting measurement attributes for

specific assets, liabilities, and transactions and for deciding when the criteria require

recognition or derecognition of an asset or a liability.

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Members of the Financial Accounting Standards Board: Donald J. Kirk, Chairman Frank E. Block Victor H. Brown Raymond C. Lauver John W. March David Mosso Robert T. Sprouse