Describe how the definitions of assets and liabilities have evolved over the years.

Question

What will be an ideal response?

Answer 1

ANSWER:
Definitions of assets have evolved from a narrow legal orientation to a broader concept of economic resources. The first definition of assets emphasized legal property but also included deferred charges because they relate to future period income statements. This aspect of the definition represents a revenue-expense approach to the financial statements. The second definition emphasized that assets are economic resources. Anything having future economic value was considered an asset. Deferred charges were separately identified in this definition but were still grouped with assets. The third definition identified the key characteristics of an asset as: (1) its capacity to provide future economic benefits; (2) control of the asset by the firm; and (3) the occurrence of the transaction giving rise to control and the economic benefits. Deferred charges were dropped from the asset definition. The economic resources approach represents a broader concept of assets than the legal property concept and is consistent with the economic notion that an asset has value because of a future income (cash) stream.

The first definition of liabilities defined them as credit balances that would be properly carried forward upon a closing of books of account according to the rules or principles of accounting, provided such credit balance is not in effect a negative balance applicable to an asset. This definition made no distinction between owners’ equity and liabilities, thus implying an entity theory view of the firm. The other two liability definitions do not mention owners’ equity, which seems to imply a proprietary view of the firm in which owners’ equity represents owners’ residual interest in the net assets. The liability portion of the first definition emphasizes legal debts. In the second definition, the liability concept is broadened to mean economic obligations. In addition, deferred credits are identified separately but are still considered to be a part of liabilities. The third and most recent definition continues the emphasis on economic obligations rather than legal debt and drops deferred credits. This definition lists three essential characteristics of an accounting liability: (1) a duty exists; (2) the duty is virtually unavoidable; and (3) the event obligating the enterprise has occurred.