This is all about: A present economic resource controlled by the entity as a result of past events.
Two very simple examples to start with:
Pat Co has purchased a patent for $20,000. The patent gives the company sole use of a particular manufacturing process which will save $3,000 a year for the next five years.
This is an asset, albeit an intangible one. There is a past event, control and future economic benefit (through cost savings).
Baldwin Co (the company) paid Don Brennan $10,000 to set up a car repair shop, on condition that priority treatment is given to cars from the company’s fleet.
This cannot be classified as an asset. Baldwin Co has no control over the car repair shop and it is difficult to argue that there are ‘future economic benefits’.
The existence of an asset, particularly in terms of control, is not reliant on:
- Physical form (hence patents and copyrights), nor
- Legal rights (hence leases).
There have regularly been arguments that control is implicit in the definition of a resource as a right that the reporting entity controls the resource. It has been decided to include and define ‘Control’ explicitly to improve clarity.
The Conceptual Framework explains ‘control‘ along some essential features captured in the following subjects:
1. Control links an economic resource to an entity Control of an economic resource
Control links an economic resource to an entity. Assessing whether control exists helps to identify the economic resource for which the entity accounts. For example, an entity may control a proportionate share in a property without controlling the rights arising from ownership of the entire property. In such cases, the entity’s asset is the share in the property, which it controls, not the rights arising from ownership of the entire property, which it does not control.
An asset (or a part of it) is an asset of some entity. That is, some assets comprise separable bundles of benefits that may be unbundled and held simultaneously by two or more entities so that each has an asset. For example, a building may provide future economic benefits to its owner, to an entity that leases space in it, and to an entity that holds a mortgage on it. Each has an interest in a different aspect of the same building, and each expects to receive cash flows from having one or more of the bundles of benefits.
2. Only one party controls a resource
An entity controls an economic resource if it has the present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it. Control includes the present ability to prevent other parties from directing the use of the economic resource and from obtaining the economic benefits that may flow from it. It follows that, if one party controls an economic resource, no other party controls that resource.
An entity must control an item’s future economic benefit to be able to consider the item as its asset. To enjoy an asset’s benefits, an entity generally must be in a position to deny or regulate access to that benefit by others, for example, by permitting access only at a price. Thus, an asset of an entity is the future economic benefit that the entity can control and thus can, within limits set by the nature of the benefit or the entity’s right to it, use as it pleases. The entity having an asset is the one that can exchange it, use it to produce goods or services, exact a price for others’ use of it, use it to settle liabilities, hold it, or perhaps distribute it to owners.
3. The present ability to directly or indirectly direct the use of an economic resource Control of an economic resource
An entity has the present ability to direct the use of an economic resource if it has the right to deploy that economic resource in its activities, or to allow another party to deploy the economic resource in that other party’s activities.
In preparing the financial statements for the year ended 31 December 2xxx, an entity has an asset only if it has the ability to obtain that asset’s future economic benefits as at that balance sheet moment/date. If an entity anticipates that it may in the future control an item’s future economic benefits but as yet does not have that control, it cannot claim that item as its asset because the transaction, other event, or circumstance conferring that control has not yet occurred.
4. Legal form of control of an economic resource Control of an economic resource
Control of an economic resource usually arises from an ability to enforce legal rights. However, control can also arise if an entity has other means of ensuring that it, and no other party, has the present ability to direct the use of the economic resource and obtain the benefits that may flow from it. For example, an entity could control a right to use know-how that is not in the public domain if the entity has access to the know-how and the present ability to keep the know-how secret, even if that know-how is not protected by a registered patent.
First stay aware, contracts may take a variety of forms and need not be in writing.
In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for control because an entity may be able to control the future economic benefits by some other means. In the absence of a clear legal responsibility, the existence of a present obligation is a matter for determination from the evidence available.
In assessing if these other means/available evidence ensure that it, and no other party, has the present ability to direct the use of the economic resource and obtain the benefits that may flow from it:
- access to the resource, or the ability to deny or restrict access to the resource;
- the means to ensure that the resource is used to achieve its objectives; and
- the existence of an enforceable right to service potential or the ability to generate economic benefits arising from a resource.
While these indicators are not conclusive determinants of whether control exists, identification and analysis of them can inform that decision.
Similarly, the presence of legal rights does not guarantee control. For example, goods may be sold subject to reservation of title, whereby a stipulation is placed in a sale of goods agreement to the effect that ownership of the goods does not pass to the buyer until the time of payment. The substance of these arrangements is that the buyer effectively has control over the future economic benefits embodied in the delivered goods unless there is an incapacity to pay. The seller, while possessing legal title and therefore the right to resume possession in the event of the buyer’s default, does not control the future economic benefits embodied in the goods.
5. Continues flow of benefits to the entity Control of an economic resource
For an entity to control an economic resource, the future economic benefits from that resource must flow to the entity either directly or indirectly rather than to another party. This aspect of control does not imply that the entity can ensure that the resource will produce economic benefits in all circumstances. Instead, it means that if the resource produces economic benefits, the entity is the party that will obtain them either directly or indirectly.
What gives the resource value is the possibility of future inflows. Although an asset derives its value from its potential to produce future benefits, the thing that the entity controls today is that existing potential, not the future economic benefits.
6. More factors imply control Control of an economic resource
Having exposure to significant variations in the amount of the economic benefits produced by an economic resource may indicate that the entity controls the resource. However, it is only one factor to consider in the overall assessment of whether control exists.
Some economic resources produce cash flows directly, whereas other economic resources are used in combination to produce cash flows. Therefore the way in which an asset or liability contributes to future cash flows identifies as one factor in the assessment of whether control exists.
Sometimes assessing control is straightforward, such as when control over an investee is obtained directly and solely from the voting rights granted by equity instruments such as shares, and can be assessed by considering the voting rights from those shareholdings. In other cases, the assessment will be more complex and require more than one factor to be considered, for example when control results from one or more contractual arrangements.
7. Agency theory – principal and agent Control of an economic resource
Sometimes one party (a principal) engages another party (an agent) to act on behalf of, and for the benefit of, the principal. For example, a principal may engage an agent to arrange sales of goods controlled by the principal. If an agent has custody of an economic resource controlled by the principal, that economic resource is not an asset of the agent. Furthermore, if the agent has an obligation to transfer to a third party an economic resource controlled by the principal, that obligation is not a liability of the agent, because the economic resource that would be transferred is the principal’s economic resource, not the agent’s. See also Stewardship and agency theory.