What is the recognition criteria of equity?


Framework for Preparation and Presentation of Financial Statements (Framework) issued by International Accounting Standards Board (IASB) is one of the important documents. Many of the basic concepts that also form the very foundation of International Accounting Standards (IASs) have been discussed in it and provides a framework for development of accounting standards as well.

Although framework defines the five elements of financial statements i.e. asset, liability, income, expense and equity but it does not provide recognition criteria for all five of the elements. If we go through the framework we will understand that there is no recognition criteria mentioned for equity.

This is not by mistake and we can understand the reason why equity has no recognition criteria by understanding the definition of equity.

Framework defines equity as follows:

Equity is the residual interest in the assets of the entity after deducting all its liabilities.

In simple words equity is just a resultant of assets left after all of the liabilities of the entity are deducted. We can understand this concept by looking at the accounting equation itself which is:

Capital + Liabilities = Asset

This can also be written as:

Capital = Asset – Liabilities

From this we can understand that if only recognition criteria of Assets and Liabilities are provided that is enough to cover the equity element as well as this is just a residual. This can also be said in another way i.e. recognition criteria for assets and recognition criteria for liabilities are collectively providing recognition criteria for equity element of financial statements.

Some of the students might still have confusion about equity recognition criteria due to other two elements of financial statements which are Income and Expense.

The recognition criteria for Income and Expenses is even more interesting and thus ultimately does not require the recognition criteria for equity to specified explicitly.

The recognition criteria for Income and Expenses are as follows:

Income is recognised in the income statement when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably.

Expenses are recognised in the income statement when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably.

By looking at the above recognition criteria for the remaining two elements we understood that even the criteria for Income and Expenses recognition is connected with asset and liability. Therefore, if these two are connected with asset and liability and equity is residual of asset and liability therefore, NO separate recognition criteria for equity is required.