Potential To Produce Economic Benefits – FAQ | IFRS

Potential to produce economic benefits

This is all about: An economic resource is a right that has the potential to produce economic benefits.

In the Conceptual Framework 2018, an asset is now specified as ‘a present economic resource controlled by the entity as a result of past events’. An economic resource, which previously had no definition, is defined as ‘a right that has the potential to produce economic benefits‘.

Previously an asset was defined as ‘a resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity’.

In other words, the potential to produce economic benefits now means that the flow of economic benefits no longer needs to be certain, or even likely (but be aware if it is not certain or likely, however, then the asset’s recognition and measurement may be affected!!). It is only necessary that the economic resource already exists and that there is at least one circumstance in which it would produce economic benefits.

A clarifying example is as follows:

The Conceptual Framework explains ‘potential to produce economic resources’ along some essential features captured in the following subjects:

1. The probability to produce economic benefits is low

A right can meet the definition of an economic resource, and hence can be an asset, even if the probability that it will produce economic benefits is low (‘right that has the potential’). Nevertheless, that low probability might affect decisions about what information to provide about the asset and how to provide that information, including decisions about whether the asset is recognised and how it is measured.

In some cases, that uncertainty, possibly combined with a low probability of inflows of economic benefits and an exceptionally wide range of possible outcomes, may mean that the recognition of aa asset, necessarily measured at a single amount, would not provide relevant information. Whether or not the asset is recognised, explanatory information about the uncertainties associated with it may need to be provided in the financial statements.

Changing how to account for an asset when the probability of an inflow of benefits is low might be considered creating additional uncertainty as to the accuracy of the individual financial reporting lines including in financial statements, however those concerns are now best addressed in recognition. The probability and resulting accounting treatment has to be judged upon on the basis of the characteristics of the reporting entity’s environment and the evidence available when the financial statements are prepared.

A low probability of economic benefits might affect recognition decisions and the measurement of an asset.

2. Examples of producing economic benefits  Potential to produce economic benefits

An economic resource could produce economic benefits for an entity by entitling or enabling it to do, for example, one or more of the following:

  1. receive contractual cash flows or another economic resource;
  2. exchange economic resources with another party on favorable terms;
  3. produce cash inflows or avoid cash outflows by, for example: Potential to produce economic benefits
    1. using the economic resource either individually or in combination with other economic resources to produce goods or provide services;
    2. using the economic resource to enhance the value of other economic resources;
    3. leasing the economic resource to another party;  Potential to produce economic benefits
  4. receive cash or other economic resources by selling the economic resource; or
  5. extinguish liabilities by transferring the economic resource.

Examples of production of economic benefits in the real world are:

  1. The manufacturing or technically productive enterprises in a particular field, country, region, or economy viewed collectively, or one of these individually. A single industry is often named after its principal product; for example, the auto industry. For statistical purposes, industries are categorized generally according a uniform classification code such as Standard Industrial Classification (SIC).
  2. Any general business activity or commercial enterprise that can be isolated from others, such as the tourist industry or the entertainment industry.
  3. A commercial enterprise that provides work performed in an expert manner by an individual or team for the benefit of its customers. The typical service business provides intangible products, such as accounting, banking, consulting, cleaning, landscaping, education, insurance, treatment, and transportation services.
  4. Extractive industry which operate any processes that involve the extraction of raw materials from the earth to be used by consumers. The extractive industry consists of any operations that remove metals, mineral and aggregates from the earth. Examples of extractive processes include oil and gas extraction, mining, dredging and quarrying.

3. The economic resource is the present right

Although an economic resource derives its value from its present potential to produce future economic benefits, the economic resource is the present right that contains that potential, not the future economic benefits that the right may produce. For example, a purchased option derives its value from its potential to produce economic benefits through exercise of the option at a future date. However, the economic resource is the present right—the right to exercise the option at a future date. The economic resource is not the future economic benefits that the holder will receive if the option is exercised.

This has been included to specifically avoid that financial statements will include future economic benefits (more or less moving away for the realisation principle towards the concept of economic value added).

4. Association between incurring expenditure and acquiring assets

There is a close association between incurring expenditure and acquiring assets, but the two do not necessarily coincide. Hence, when an entity incurs expenditure, this may provide evidence that the entity has sought future economic benefits, but does not provide conclusive proof that the entity has obtained an asset. Similarly, the absence of related expenditure does not preclude an item from satisfying the definition of an asset and thus becoming a candidate for recognition in the balance sheet. Assets can include, for example, rights that a government has granted to the entity free of charge or that another party has donated to the entity may satisfy the definition of an asset.

A capital expenditure is the use of funds or assumption of a liability in order to obtain or upgrade physical assets. The intent is for these assets to be used for productive purposes for at least one year. This type of expenditure is made in order to expand the productive or competitive posture of a business. Examples of capital expenditures are funds paid out for buildings, computer equipment, machinery, office equipment, vehicles, and software. An example of an asset upgrade is adding a garage onto a house, since it increases the value of the property, whereas repairing a dishwasher merely keeps the machine in operation. Capital expenditures tend to be quite substantial in certain industries, such as utilities and manufacturing.

A capital expenditure is recorded as an asset, rather than charging it immediately to expense. It is classified as a fixed asset, which is then charged to expense over the useful life of the asset, using depreciation. For example, if you acquire a €25,000 asset and expect it to have a useful life of five years, then charge €5,000 to depreciation expense in each of the next five years. The asset is initially recorded in the balance sheet, while the periodic depreciation charges against it appear in the income statement over the five years.

Since there is a record keeping cost associated with capital expenditures, these items are generally charged to expense if they cost less than a certain predetermined limit, which is known as the capitalization limit. For example, if a company’s capitalization limit is €2,000, then a computer costing €1,999 would be charged to expense in the period incurred, whereas it would be recorded as a fixed asset if it cost €2,001.

The reverse of a capital expenditure is an operational expenditure, where the cost is incurred strictly for current operations. Always charge operational expenditures to expense when incurred. Since they are charged to expense in the period incurred, they are also known as period costs.

Leave a comment