In this article we will discuss about Gains and Losses:- 1. Meaning of Gains and Losses 2. Features of Gains and Losses 3. Recognition.
Meaning of Gains and Losses:
Gains are defined as increase in net assets other than from revenues or from changes in capital. Gains are increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from revenues or investment by owners.
Losses are decreases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distribution to owners. Gains and losses represent favourable and un-favourable events not directly related to the normal revenue producing activities of the enterprise.
Revenue and expenses from other than sales of products, merchandise, or services such as disposition of assets may be separated from other revenue and expenses and the net effects disclosed as gains or losses.
Other examples of gains and losses are sizeable write-down of inventories, receivables, and capitalized research gains and losses on sale of temporary investments and gains and losses on foreign currency devaluations.
Features of Gains and Losses:
Gains and losses possess the following characteristics:
(1) Gains and losses result from enterprises incidental transactions and from other events and circumstances stemming from the environment that may be largely beyond the control of individual enterprises and their management. Thus gains and losses are not all alike. They are of different types, even in a single enterprise.
(2) Gains and losses may be described or classified according to sources. Some gains and losses are net results of comparing the proceeds and sacrifices (costs) in incidental transactions with other entities—for example, from sales of investments in marketable securities, from disposition of used equipment, or from settlement of liabilities at other than their carrying amounts.
Other gains or losses result from non-reciprocal transfers between an enterprise and other entities that are not its owners—for example, from gifts or donation, from winning a law-suit, from thefts, and from assessments of fines or damages by courts.
Still other gains/losses result from holding assets or liabilities while their value changes—for example, from price changes that cause inventory items to be written down from cost to market, from changes in market prices of investments in marketable equity securities accounted for at market values or at the lower of cost and market, and from changes in foreign exchanges rates.
And still other gains or losses result from other environmental factors, such as natural catastrophes (for example, damages to or destruction of property by earthquake or flood), technological changes (for example, obsolescence).
(3) Gains and losses may also be described as operating or non-operating depending on their relation to an enterprise’s earning process. For example, losses on writing down inventory from cost to market are usually considered to be operating losses, while losses from disposing of segment of enterprises are usually considered non-operating losses.
Other descriptions or classifications of gains and losses, are also possible. A primary purpose for describing or classifying gains and losses and for distinguishing them from revenues and expenses associated with normal revenue-producing activities is to make display of information about an enterprise’s performance as useful as possible.
Recognition of Gains and Losses:
The realisation principle is more strictly followed in recognition of gains and losses. Gains are not generally recognised until an exchange or sale has taken place. However, an increase in the market value of securities may under some circumstances, be sufficient evidence to recognise gain.
However, some persons oppose recognising appreciation in values due to two reasons:
(a) Increase in value is uncertain.
(b) An increase in value does not generate liquid resources that can be used for payment of dividends.
The emphasis on liquid resources and cash flows, although useful for decision-making purposes, may not be relevant for income measurement purposes. Relative certainty and verifiability of measurements are satisfactory guides for income measurement purposes.
For investments in marketable securities, the recognition of gains and losses arising from material changes in market prices is being accepted in accounting although no sale or exchange might have taken place. However, change in value of land is generally not recorded in accounting.
The criteria for recognition of losses are similar to the criteria for the recognition of period expenses. Losses cannot be matched with revenue, so they should be recorded in the period in which it becomes fairly definite that a given asset will provide less benefit to the firm than indicated by the recorded valuation.
In the case of sale of an asset or loss by fire or other catastrophe, the timing of the event is fairly definite. If an asset has lost its usefulness, the loss should be recognised and the final disposition should not be waited for. Loss arising should not be carried forward to future periods. If it is fairly definite and if the amount of the loss can be measured reasonably well, it should be recorded as soon as it is ascertainable.
Recognising Un-Realised Holding Gains and Losses:
Gains are generally not recognised until sale or exchange has taken place. However, during recent years, a large number of writers have expressed the opinion that the usefulness of financial statements would be enhanced by recognising un-realised gains or losses which arise while assets are being held.
These writers advocate reporting fixed assets and inventories of materials and unfinished products at current replacement costs and finished products ready for sale at realisable market prices rather than at historical acquisition costs.
Such proposals are concerned with changes in values of individual assets rather than with changes in the purchasing power of money which is reflected in the general price level. Replacement costs are measured by appraising individual assets (perhaps with the aid of price indexes for specific classes of assets), while the general price level is measured by a general price index for all commodities and services.