week 2 - measuring and reporting financial position

PowerPoint Presentation to accompany:

Chapter 2

Measuring andreporting financial positionCover illustration PinnacleAnimates /Shutterstock

Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781486008797/Atrill/Accounting: An Introduction 6/e

Learning Objectives


Nature and purpose of thestatement of financial positionThe purpose of the statement of financial position is to set out the financial position of a business at a particular point in timeAlso referred to as a balance sheetContains a snapshot of the assets, liabilities and equity position of the entity at a particular point in time


Example of Balance SheetMama Dudes CafBalance sheet as at 30 JuneBalance dateReflects duality system & accounting equationAssets = Liabilities + Equity

2010200920102009Cash at bank12 00030 000Accounts payable37 00055 000Accounts receivable12 00014 000Mortgage10 00010 000Inventory30 00028 000Loans45 00045 000Motor vehicles40 00036 000Total liabilities92 000110 000Buildings80 00070 000Owners equity82 00068 000Total assets174 000178 000Total liabilities & equity174 000178 000


THE ACCOUNTING EQUATION

If ABC Ltd has assets totalling $980 000, and liabilities totalling $630 000, then the amount of equity must be $350 000 A = L + E $980,000 = $630,000 + $350,000

>>Expresses the relationship between assets of an entity and how those assets are financed


THE ACCOUNTING EQUATIONTrading introduces additional transactions to the statement of financial position. To cover the effect of trading, the statement of financial position equation is extended: Assets = Liabilities + Equity

Income Expenses = Profit (or Loss)

Assets = Liabilities + Opening Equity + Profit (or Loss) +/- Other Changes in Equity


AssetsMain characteristics:A probable future economic benefitThe business has exclusive right to control the benefitThe benefit must arise from some past transaction or eventThe asset must be capable of reliable measurement in monetary termsImportant: All four conditions must apply


Assets


AssetsAssets may be:Tangible (a physical substance, e.g. land)ORIntangible (have no physical substance, e.g. patent)Examples of assetsLand, machinery, fixtures and fittings, patents and trademarks


Claims against assetsOther side of statement of financial position includes claims against the assets of an entity or simply the different interests in those assetsTwo types of claims:External claims liabilitiesInternal claims owners equity (equity or capital)


LiabilitiesClaims against assets of the business other than those of owner(s)Recognition criteria (similar to assets):probable that an outflow will occurcapable of reliable measurement in monetary terms


LiabilitiesExamples of liabilitiesAccounts payable, staff entitlements, loans and other credit facilities, and other social or moral obligations, provision for employee bonuses or owners distributionProvisionEstimated liability, greater uncertainty regarding the amount or timing of the amount than for a normal liability, e.g. warranty provisionsContingent liabilityPotential liability that might arise if a particular event occurs Not recognised in financial position until the event actually occurs


EquityRepresents the claim of the owner(s) against the businessDefined as residual interest in the assets of the entity after deducting all its liabilities

Examples of equity:Share (equity) capitalRetained profitsReserves

EQUITY = ASSETS LIABILITIES


Format of statement of financial positionTwo basic choices:Horizontal format -also referred to as the T account formatVertical format also referred to as the narrative format


Horizontal format


Example 2.2


Vertical formatTwo approaches within vertical format:


Example 2.3


The classification of assetsAssets are classified as current where:they are held for sale or consumption during the businesss normal operating cyclethey are expected to be sold within the next yearthey are held principally for trading, and/orthey are cash, or near-cash (such as easily marketable, short-term investments)All other assets are classified as non-current


Operating cycleThe businesss operating cycle is the time between the acquisition of the assets and their ultimate realisation in cash or cash equivalents


Examples of current and non-current assetsCurrentcash and cash equivalentsaccounts receivableinventoryshort-term investmentsNon-currentfixtures and fittings office equipmentmotor vehicles landplant and machinerygoodwill


Classification of liabilitiesLiabilities are classified as current where:they are expected to be settled within the businesss normal operating cyclethey are held principally for trading purposesthey are due to be settled within a year after the date of the relevant statement of financial position, and/orthere is no right to defer settlement beyond a year after the date of the relevant statement of financial positionAll other liabilities are classified as non-current


Examples of current and non-current liabilitiesCurrentaccounts payable bank overdraftbank loan (repayable within 12 months)revenue received in advance (e.g. subscriptions)Non-currentmortgage loanlong-term loans


Classification of owners equityTypically three categories:Owners equity contributed initial funds contributed plus any specific increasesRetained profit (retained earnings) profits made less any amounts drawn out by the ownersOther reserves profits that result from other events, e.g. revaluation reserve


Classification of owners equity


Financial position at a point in timeThe statement of financial position is a statement of the financial position of the business at a specified point in timeA snapshot of a single moment in time of the businessIt is important to establish when reading a statement of financial position the date it was drawn upIn Australia and New Zealand, normally 30 June but businesses free to choose


Factors influencing the form and content of the financial reportsTwo most significant influences:Traditional accounting conventions and doctrines that have underpinned accounting practice for decadesContinued development of professional and statutory accounting standards


Accounting conventionsThe principles, assumptions or accepted ideas on which accounting rules, records and reports were or are basedKnown as GAAP (generally accepted accounting principles)


Accounting conventionsBusiness entity convention For accounting purposes, the business and its owner(s) are treated as separate and distinctHistoric cost convention Assets should be recorded at their historic (acquisition) cost or equivalentPrudence convention Holds that caution should be exercised when making accounting judgements; often means anticipating losses but only recognising realised profits


Accounting conventionsGoing concern (continuity) convention Assumption that the business will continue operations for the foreseeable future, i.e. no intention or need to liquidate the businessDual aspect convention Each transaction has two aspects and each aspect must be recorded in the financial statementsMoney measurement convention Accounting should only deal with those items which are capable of being expressed in monetary termsStable monetary unit convention Money, the unit of measurement, will not change in value over time


Valuing non-current assetsNon-current assets have lives that are either finite or indefiniteNon-current assets with finite lives As these assets are used up over time, their cost is recognised as an expense in each period (depreciation or amortisation)Non-current assets with indefinite lives Assets not used up over time so not subject to routine annual depreciation over time, e.g. land is not depreciated


Valuing non-current assetsFair valueAn alternative method for recording non-current assets, provided fair value can be reliably estimatedFair value means the current market value (i.e. the exchange value in an arms length transaction between knowledgeable willing parties )Impairment of assetsWhere an asset suffers a fall in value, meaning its carrying amount is higher than the amount that could be recovered from continued use or saleCould be caused by changes in market conditions, technological obsolescenceFall in value written off as a lossImpairment also applies to current assets such as inventories


Usefulness of the statement of financial positionProvides insights about how the business is nanced and how its funds are deployedProvides insights into the liquidity of the businessCan provide a basis for assessing the value of the businessProvides insights into the mix of assets held by the businessPerformance can be assessed against amount of investment

Here is an example of a balance sheet:Note balance dateNote comparative figures Remember - the accounting equation specifies that the entitys assets equal the sum of the entitys liabilities and equity.

The duality system of recording business transactions means that the business transactions have a dual effect on the accounting equation such that the equation remains in balance after the recording of each transaction. This is why a balance sheet, prepared as at any point in time, will balance.

Liquidity: The ability of an entity to meet its short-term financial commitments (obligations that are expected to become due within the next year or operating cycle).

Accounting professions and regulators in various countries, including Australia, New Zealand and the United States, have developed frameworks for the preparation and presentation of financial statements. Such frameworks define the elements of the financial statements and recognition criteria applied to the elements. While there are some differences, the definition and recognition criteria to be applied are generally fairly consistent across frameworks.

Assets: resources controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity

Definition: 1.past event; 2. control; 3. future benefitsRecognitionon: 1. probable; 2. reliableExercise: AE 2.10Liabilities: present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

Definition criteria: 1.present obligation; 2.past event; 3.outflow economic resourcesRecognition criteria: 1. probable; 2. reliable

Contingent liabilities arise from a past event that may be confirmed only by uncertain future events not controllable by the entity

https://www.youtube.com/watch?v=Mchj7JaVD2k

Equity is defined in the Framework (para. 49(c)) as the residual interest in the assets of the entity after deducting all its liabilities. This means that equity cannot be determined without reference to assets and liabilities.

Exercise: AE 2.3

Exercises: AE 2.7; AE 2.9; AE 2.4 Exercise: AE 2.9 Horizontal format; AE 2.4 Vertical format; Operating cycle is the length of time it takes for an entity to acquire goods, sell them to customers and collect the cash from the sale.

Current assets: cash and other assets that are reasonably expected to be converted to cash or used in the entity within one year or one operating cycle, whichever is longer.Non-current assets: assets that are not expected to be consumed or sold within one year or one operating cycle.

Current liabilities: obligations that can reasonably be expected to be paid within one year or one operating cycle.Non-current liabilities: obligations that are not classified as current liabilities (i.e. obligations not expected to be paid after one year or outside one normal operating cycle).

Unearned revenue:-Subscriptions received in advance by a magazine publisher -Rental received in advanceIntangible assets with indefinite lives (e.g. goodwill) are always valued at cost and tested for impairment at least annually rather than amortized

week 2 - measuring and reporting financial position

Documents

e nature

e assetscopyright

e assetsassets

equity position

loss assets

e assetsmain characteristics

e learning objectivescopyright

total liabilities equity174