In order for an asset to be recognized in the financial statements, it must the following definition laid down in the IASB Framework:
Asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (IASB Framework).
It is worth noting that the framework defines asset in terms of control rather than ownership. While control is generally evidenced through ownership, this may not always be the case. Therefore, an asset may be recognized in the financial statement of the entity even if ownership of the asset belongs to someone else. For instance, if a machine is leased to a company for the entire duration of its useful life, the machine may be recognized in its Statement of Financial Position (Balance Sheet) since the entity has control over the economic benefits that would be derived from the use of the asset. This illustrates the use of Substance Over Form whereby the economic substance of the transaction takes precedence over the legal aspects of a transaction in order to present a true and fair view.
Since, by definition, an asset must be controlled by the entity in order for it to be recognized in the financial statements, certain ‘Assets’ would not qualify for recognition. Consider a highly dedicated workforce. Generally speaking, a hardworking and motivated workforce is the most valuable asset of any successful company. But does an entity has control over its workers? The answer is no, because an employee may quit an organization any day and seek employment in a rival firm much to the detriment of the company. Therefore, such ‘Assets’ may not be recognized in the financial statements of a company.
Apart from meeting the above definition, the Framework has advised the following recognition criteria that ought to be met before an asset is recognized in the financial statements.
- The inflow of economic benefits to entity is probable.
- The cost/value can be measured reliably.
With regard to the first criteria, it makes sense to only recognize an asset if the benefits from its use or sale are likely.
The second test ensures that the financial statements present assets that can be measured objectively. For instance, how does a person place value on something subjective such as customer loyalty or a dedicated employee?