Assets and Liabilities: Will FASB Redefine the Basics?

A recent Financial Accounting Standards Board (FASB) meeting addressed updating the so-called “building blocks” of financial statements. Board members want to simplify the definitions of assets and liabilities and make them easier to understand. Major changes to these definitions could affect how items are classified on companies’ balance sheets.

Standard-setting framework

The Conceptual Framework is a set of guidelines the FASB references when writing and amending accounting standards. The FASB issued its first Concepts Statement in 1978. Six more were published by 2000. Concepts Statements are used to write U.S. Generally Accepted Accounting Principles (GAAP), but they aren’t considered part of the FASB’s official authoritative guidance.

Statement of Financial Accounting Concepts (CON) No. 6, Elements of Financial Statements, was published in 1985. It defines the building blocks with which financial statements are constructed, including the following definitions:

Assets. Probable future economic benefits obtained or controlled by a particular entity as the result of past transactions or events.

Liabilities. Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Several terms in these definitions — including “probable,” “future economic benefit,” “past transaction or event,” “future sacrifice of economic benefits,” and “control” — have sparked debates among accountants and caused problems with financial reporting.

Work in progress

The overall Conceptual Framework remains incomplete, and the FASB’s effort to update it has been a long-running endeavor. In 2004, the FASB partnered with the International Accounting Standards Board (IASB) to try to converge the U.S. and international financial reporting frameworks. However, the fallout from the 2008 financial crisis forced the FASB and IASB to set aside the joint project to deal with more pressing issues, and the convergence effort never resumed. Now the boards are working independently on updating their frameworks.

On August 30, the FASB agreed to consider trimming the definition of an asset to “the present right of the entity to an economic benefit.” The board was less decisive about where it could head with the definition of a liability, which depends on how an asset is defined.

The background materials the FASB staff prepared for the meeting said that a liability, “in many respects, is a mirror image of the definition of an asset.” One proposal presented was to redefine a liability as “a present obligation of the entity to transfer an economic benefit.”

The FASB hasn’t committed to any changes yet, however. Board members want to see how the proposed definitions work in real life when the FASB is wrestling with a standard-setting question.

For example, in July, the FASB’s Emerging Issues Task Force (EITF) tried to resolve how to account for the costs and fees for setting up cloud-computing arrangements, and part of the question hinged on whether these service contracts meet the definition of an asset. Testing the proposed definitions in these types of debates would be helpful. FASB Chairman Russell Golden suggested that the board also not confirm the definition of a liability or asset until it considers related terms such as revenues and expenses.

Stay tuned

In addition to focusing on key accounting terms, the FASB’s Conceptual Framework project also targets presentation and measurement concepts. Contact your CPA for the latest developments on this long-running endeavor.

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