Chapter 2

Introduction to accounting
Measuring And Reporting Financial Positions

Nature and purpose of the statement of financial

position

The purpose of the statement of financial position is to set out the

financial position of a business at a particular point in time
Also referred to as a balance sheet
Contains a snapshot of the assets, liabilities and equity position of the
entity at a particular point in time

Assets
Main characteristics:

A probable future economic benefit

The business has exclusive right to control the benefit
The benefit must arise from some past transaction or event
The asset must be capable of reliable measurement in monetary terms

Important: All four conditions must apply

Assets may be:

Tangible (a physical substance, e.g. land)

OR

Intangible (have no physical substance, e.g. patent)

Examples of assets

Land, machinery, fixtures and fittings, patents and trademarks,

accounting assets, investments

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Claims against assets

Other side of statement of financial position includes claims against

the assets of an entity or simply the different interests in those
assets
Two types of claims:
o External claims liabilities
o Internal claims owners equity, equity or capital

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Liabilities

Claims against assets of the business other than those of owner(s)

Recognition criteria (similar to assets):
o probable that an outflow will occur
o capable of reliable measurement in monetary
terms

Equity

Represents the claim of the owner(s) against the business

Defined as residual interest in the assets of the entity after deducting
all its liabilities
Examples of equity:
o Retained profits
o Share capital
o Reserves

The accounting equation

Assets = Liabilities + Equity

Accounting equation always in balance:

Cost of assets
always equals
Cost of funds raised to acquire assets, i.e. liabilities or equities

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

The effect of trading operations on the statement

of financial position

Trading 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 at beginning of period
+ Profit (or loss)
+/- Other changes in equity

The classification of assets

Assets are classified as current where:

o they are held for sale or consumption during the
businesss normal operating cycle
o they are expected to be sold within the next year
o they are held principally for trading, and/or
o they are cash, or near-cash (such as easily
marketable, short-term investments)

All other assets are classified as non-current

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Operating cycle
The 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 assets

Current

Non-current

cash at bank
accounts receivable
inventory
short-term investments

fixtures and fittings

office equipment
motor vehicles
land
plant and machinery

Classification of liabilities

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Liabilities are classified as current where:

o they are expected to be settled within the businesss
normal operating cycle
o they are held principally for trading purposes
o they are due to be settled within a year after the date
of the relevant statement of financial position, and/or
o there is no right to defer settlement beyond a year
after the date of the relevant statement of financial
position

All other liabilities are classified as non-current

Examples of current and non-current liabilities

Current

accounts payable
bank overdraft
bank loan (repayable within 12 months)
revenue received in advance (e.g. subscriptions)

Non-current

mortgage loan
long-term loans

Classification of owners equity

Typically three categories:

Owners equity contributed initial funds contributed plus any

specific increases
Retained profit (retained earnings) profits made less any
amounts drawn out by the owners
Other reserves profits that result from other events

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Classification of owners equity

Format of statement of financial position

Two basic choices:

Horizontal format also referred to as the

T account format
Vertical format also referred to as the narrative format

Horizontal format

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Example 2.2

Vertical format
Two choices within vertical format:

Example 2.3

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Financial position at a point in time

The statement of financial position is a statement of the financial

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

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Factors influencing the form and content of the

financial reports
Two most significant influences:
1. Traditional accounting conventions and doctrines that have
underpinned accounting practice for decades
2. Continued development of professional and statutory accounting
standards

Accounting conventions

The principles, assumptions or accepted ideas on which accounting

rules, records and reports were or are based
Known as GAAP (generally accepted accounting principles)

Business entity convention For accounting purposes, the business

and its owner(s) are treated as separate and distinct

Historic cost convention Assets should be recorded at their historic

(acquisition) cost or equivalent

Prudence convention Holds that caution should be exercised when

making accounting judgements; often means anticipating losses but
only recognising realised profits

Going concern (continuity) convention Assumption that the

business will continue operations for the foreseeable future, i.e. no
intention or need to liquidate the business

Dual aspect convention Each transaction has two aspects and

each aspect must be recorded in the financial statements

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Money measurement convention Accounting should only deal

with those items which are capable of being expressed in monetary
terms

Stable monetary unit convention Money, the unit of

measurement, will not change in value over time

Valuing non-current assets

Non-current assets have lives that are either finite or indefinite

Non-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

Fair value

An alternative method for recording non-current assets, provided fair

value can be reliably estimated

Fair value means the current market value (i.e. the exchange value in
an arms length transaction)

Impairment of assets

Where an asset suffers a fall in value, meaning its carrying amount is

higher than the amount that could be recovered from continued use or
sale

Could be caused by changes in market conditions, technological

obsolescence

Fall in value written off as a loss

Impairment also applies to current assets such as inventories

Usefulness of the statement of financial position

Chapter 2
Introduction to accounting
Measuring And Reporting Financial Positions

Provides insights about how the business is financed and how its funds
are deployed
Provides insights into the liquidity of the business
Can provide a basis for assessing the value of the business
Provides insights into the mix of assets held by the business
Performance can be assessed against amount of investment