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Chapter 2

Measuring and
reporting financial
position

PowerPoint Presentation to accompany:


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Learning Objectives

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

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

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

Example of Balance Sheet


Mama Dudes Caf
Balance sheet as at 30 June
2010

2009

Balance
date
2010

2009

Cash at bank

12 000

30 000 Accounts payable

37 000

55 000

Accounts receivable

12 000

14 000 Mortgage

10 000

10 000

Inventory

30 000

28 000 Loans

45 000

45 000

Motor vehicles

40 000

36 000 Total liabilities

92 000

110 000

Buildings

80 000

70 000 Owners equity

82 000

68 000

174 000

178 000

Total assets

174 000

178 000 Total liabilities & equity

Reflects duality system & accounting equation


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

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

$980,000 =

L
$630,000

$350,000

>>Expresses the relationship between assets of an


entity and how those assets are financed
Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781486008797/Atrill/Accounting: An Introduction 6/e

THE ACCOUNTING EQUATION

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


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

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

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

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

Assets

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

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

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)

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

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

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

Liabilities
Examples of liabilities
Accounts payable, staff entitlements, loans and other credit facilities, and
other social or moral obligations, provision for employee bonuses or
owners distribution
Provision
Estimated liability, greater uncertainty regarding the amount or timing of
the amount than for a normal liability, e.g. warranty provisions
Contingent liability
Potential liability that might arise if a particular event occurs
Not recognised in financial position until the event actually occurs

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

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

EQUITY = ASSETS LIABILITIES

Examples of equity:
o
o
o

Share (equity) capital


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

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

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

Horizontal format

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

Example 2.2

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

Vertical format
Two approaches within vertical format:

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

Example 2.3

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

The classification of assets

Assets are classified as current where:


o

they are held for sale or consumption during the businesss


normal operating cycle

they are expected to be sold within the next year

they are held principally for trading, and/or

they are cash, or near-cash (such as easily marketable,


short-term investments)

All other assets are classified as non-current

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

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

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

Examples of current and non-current


assets
Current

Non-current

cash and cash equivalents

fixtures and fittings

accounts receivable

office equipment

inventory
short-term investments

motor vehicles
land
plant and machinery
goodwill

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

Classification of liabilities

Liabilities are classified as current where:


o

they are expected to be settled within the businesss normal


operating cycle

they are held principally for trading purposes

they are due to be settled within a year after the date of the
relevant statement of financial position, and/or

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


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

Examples of current and non-current


liabilities
Current

Non-current

accounts payable

mortgage loan

bank overdraft

long-term loans

bank loan (repayable


within 12 months)
revenue received in
advance (e.g.
subscriptions)
Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781486008797/Atrill/Accounting: An Introduction 6/e

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, e.g. revaluation reserve

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

Classification of owners equity

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

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

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

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

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

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)

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

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

Accounting conventions

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

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

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

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, e.g. land is not depreciated

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

Valuing non-current assets


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

Usefulness of the statement of


financial position
Provides insights about how the business is nanced
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
Copyright 2015 Pearson Australia (a division of Pearson Australia Group Pty Ltd) 9781486008797/Atrill/Accounting: An Introduction 6/e

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