Lecture 4 Lecture Notes 2011

Lecture 4 Unit 3 –Financial Position (continued) Learning Objectives • Explain the nature and purpose of the balance sheet Demonst strat rate e an under underst stand andin ing g of asse assets ts in term terms s of defi defini niti tion, on, reco recogni gniti tion on,, • Demon measurement and classification • Demonst Demonstrate rate an underst understand anding ing of liabi liabilit lities ies in terms terms of definiti definition, on, recogn recogniti ition, on, measurement and classification • Discuss the nature and classification of owner’s equity • Explain the basic accounting equation • ontrast the alternative balance sheet formats • Discuss the main factors that influence the content and values in a balance sheet • !repare a simple balance sheet •  "nalyse balance sheets of reporting entities • #tate the potential limitations of the balance sheet in portraying the financial position of an entity

The Classification of Assets  "ssets are normally categorised as either current, or non$current% urrent assets& • • •

 "re not held on a continuing basis ba sis 'nclude cash and other assets expected to be consumed or converted into cash within the operating cycle  "lso include inventory, trade debtors and pre$payments pre$pa yments

AASB 101 Present Presentation ation of Financial Financial State!en State!ents" ts" requi require res s a (cur (curre rent nt asse asset’ t’ to be

classified according to the following criteria& a) The asset is expected expected to be realised in, or is intended for sale or consumption consumption in, the entity’s normal operating cycle; b) The asset asset is held held primari primarily ly for the the purpose purpose of being being trade traded; d; c) The asset asset is expected expected to be realis realised ed within within twelve twelve months months after the report reporting  ing  date; or  d) The The asse assett is cash cash or a cash cash equiv equival alen entt unle unless ss it is restri restrict cted ed from being  being  exchanged or used to settle a liability for at least twelve months after the reporting date

)on$urrent assets& • • • •

*eld for the purpose of generating wealth, rather than for resale +ay be seen as the tools of the business )ormally held on a continuing basis for a minimum period of one year  'ncludes (goodwill purchased’ $ see page -

AASB 101 Presentation of Financial State!ents" requires assets to be classified as non$

current if they do not satisfy any of the criteria for being classified as current .previous slide/

The Classification of Lia#ilities Liabilities are normally categorised as either current or non$current urrent liabilities& •  "mounts due for repayment to outside parties within 01 months of the statement of  financial position date AASB 101 Presentation of Financial State!ents"  requires a liability to be classified as

current when it satisfies the following criteria& a) The liability is expected to be settled in the entity’s normal operating cycle; b) The liability is held primarily for the purpose of being traded; c) The liability is due to be settled within twelve months after the reporting date; or  d) The entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the reporting date

 ""#2 0-0 (!resentation of 3inancial #tatements’ also requires that liabilities be classified according to their nature% 4his classification can be on& • •

urrent 5 )on$urrent basis, or  4he order of liquidity .payment/

4he alternative liquidity classification may be used for liabilities if it provides more relevant and reliable information

$%ners" &'uit ($& or &'uit) *efinition+ • 4he claim of the owner.s/ against the business •

 ""#2 3ramewor6 defines equity as the 7residual interest in the assets of the entity after  deducting all its liabilities%8

Classification of owners’ equity:

Owners’ equity is normally classified as follows for a sole trader5sole proprietorship& 0/ apital 1/ Drawings Owners’ equity is normally classified as follows for a partne rship& 0/ apital account for each partner  1/ urrent account for each partner .optional/ Owners’ equity is normally classified in three separate categories for a company& 0/ Owners’ equity contributed .share capital/ $ represents profits left in the business by the owners 1/ 9eserves :/ 9etained profit

't is common to combine categories 1 and : into (other reserves’ and then have them listed as sub$categories of (other reserves’ such as .a/ retained profits and .b/ other reserves% )ote& 9eserves represent ownership interests in the assets, not the assets themselves% 9eserves are not separate deposits of cash available for other purposes%

For!ats for Balance Sheets

Current Assets

+ Non-Current = Current + Non-Current + Owners’ Assets

Liabilities

Liabilities

Fi,ure 3-. 4he *ori;ontal layout and entity approach

4he equation for the hori;ontal form of balance sheet layout &/a!le+ page : of textboo6 for 2rie +anufacturing .reproduced in lecture notes/

Brie Manufacturing Balance Sheet as at 31 December 2008 $ $ Current assets Cash at bank 12,00 0 Trade debtors 18,00 0 Inentor! 23,00 0 "3,000

$ Current liabilities Trade creditors

$

37,00 0

 Non current liabilities

#oan

"0,00 0 87,000

 Non current  assets otor ehicle 1%,00 0 )lant and 30,00 machiner! 0 -reehold 'remises ",00 0

Owners’ equity

&'enin( balance *dd 'ro+it

%,000 Total assets

17,00 0

#ess dra/in(s ndin( balance Total liabilities and owners’  equity

"0,00 0 1,00 0 .,00 0 ,000 .0,000 17,00 0

Source: ccounting!n "ntroduction, #th edition, trill, $c%aney, &arvey ' (enner, earson *ducation ustralia +-

Equity

For!ats for Balance Sheets (continued)

Current Assets

Non-Current + Assets

-

Current Non-Current   Liabilities Liabilities

-

Fi,ure 3-3 4he , 1-- that we used in a previous lecture activity% ?sing this information, prepare a fully classified 2alance #heet .using the hori;ontal format/ for "% Dunn, #olicitor, as at +arch 0>, 1--%

Account Name Bank &++ice +rnitre4+ittin(s Com'ter &++ice stationer! &++ice ei'ment #oan56cellent -inance #td re'a!able in 2013 Ca'ital5*9 Dnn Dra/in(s5*9 Dnn

$ %%,700 10,000 3,000 300 %,000 %,000 113,200 200

#olution&

Dunn, Solicitor Balance Sheet as at March 15, 2009 Assets

Liailities

!"ners e#uit

Lecture Actiit . (Alication &/ 3-2  Adated)

4he following is a list of assets and claims of a manufacturing business, @e +a6e 't Ltd at Aune :-, 1-0-&

Bank oerdra+t -reehold land and bildin(s Inentor! o+ ra/ materials Trade creditors )lant and machiner! #oan +rom ational *stralia Bank Inentor! o+ +inished (oods Delier! ehicles Trade debtors

$ 22,000 2",000 18,000 23,000 127,000 100,000 28,000 ",000 3,000

!repare a balance sheet in the standard vertical format incorporating these figures% &int: 4here is a missing figure which needs to be calculated and inserted% Source: ccounting!n "ntroduction, #th edition, trill, $c%aney, &arvey ' (enner, earson *ducation ustralia +-

#OL?4'O)& %e Ma&e 't Lt( Balance Sheet as at )une *0, 2010

$

$

Factors nfluencin, the For! and Content of the Balance Sheet 4here are three main influences on the accounts included in the balance sheet& 0% 4raditional accounting conventions and doctrines

1% +ore recent theoretical developments in conceptual framewor6 projects :% !rofessional and statutory accounting standards

Conentional Accountin, Practice+ • +ade up of doctrines, principles, assumptions and accepted ideas on which accounting rules, records and reports were or are based • 4hese have collectively been 6nown as B""! .Benerally "ccepted "ccounting !rinciples 5 !ractices/ 2usiness Entity onvention& • *olds that for accounting purposes, the business and its owner.s/ are treated as separate and distinct +oney +easurement onvention& • *olds that accounting should only deal with those items which are capable of being expressed in monetary terms *istoric ost onvention& • *olds that assets should be recorded at their historic .acquisition/ cost Boing oncern .ontinuity/ onvention& • *olds that the business will continue operations for the foreseeable future i%e% no intention or need to liquidate the business Dual "spect onvention& • *olds that each transaction has two aspects and that each aspect must be recorded in the financial statements onservatism 5 !rudence onvention& • *olds that financial reports should err on the side of caution vis$C$vis, anticipating losses but only recognising realised profits $ther conentions include+ #table monetary unit convention, Objectivity 5 reliability

convention, "ccounting period convention, 9ealisation convention and +atching convention% 3urther details are on pp 0-0 $ 0-:

The Concetual Fra!e%or5+ • 3our #tatements of "ccounting oncepts .#"s/ were current up until 1--=, 6nown as #"s 0 $ = • #" : and #" = have now been replaced by the adoption of the ""#2 3ramewor6, #" 0 and #" 1 continue in their previous form • @hile the framewor6 and statements are not mandatory, they have significant influence on new and revised standards being issued Accountin, Standards+ • 4he history and significance of accounting standard setting in "ustralia is covered in detail in chapter 1 • 9egarding the balance sheet, there are numerous standards that directly affect recording and reporting assets, liabilities and owners’ equity • 4he implications of the applicable "ustralian "ccounting #tandards will continue to be considered

Basis of 6aluation of Assets on the Balance Sheet

@hile the (historical cost’ convention underlies the conventional accounting system, other  conventions have led to departures from it% Examples include& !rudence convention  "ccounting !eriod 5 Boing oncern conventions 3ull Disclosure 5 9elevant 3inancial 'nformation convention − −

Basis of 6aluation of Lia#ilities on the Balance Sheet

@hile liabilities in general do not have the same range of alternative measures as assets, there are still several alternative bases for measurement, both in practice and in the accounting standards% 4hese include& 4he ontracted "mount Estimate of Expected 3uture #acrifice !resent -,--b% Other liabilities of :-,--c% !rofit of 1-,--d% 'ncome of 1-,--Source: ccounting Study .uide, &oggett, *dwards, $edlin ' Tilling, repared by %atimer, /iley ublishing +-

Su!!ar of Unit 3 7- Continued 7-

4ry summarising what we have covered in ?nit :

Lecture 2 Unit 4  Financial Perfor!ance Learning Objectives • #tate the purpose of the income statement .profit and loss/ • Explain the relationship between the income statement and the balance sheet • !resent the profit and loss equation and identify alternative formats for the income statement • Demonstrate an understanding of income in relation to definition, recognition, classification and measurement • Demonstrate an understanding of expenses in relation to definition, recognition, classification and measurement • Distinguish between accrual and cash$based transaction recognition •  "nalyse expense recognition for non$current tangible asset s •  "nalyse expense recognition for accounts receivable • !repare an income statement from relevant financial information • 9eview and interpret income statements 0ote that the page readings for this topic are from chapter # and there are only selected   pages that you need to read1 lease refer to t he lecture2reading guide in the Study %earning  .uide for details1

NOTE: you will not be required to calculate profit using the stock  approach. You will need to be aware of the theoretical aspects of  the stock approach.

The nco!e State!ent 4he purpose of the income statement is to measure and report how much profit .wealth/ the business has generated over a period% • •

rofit  .or loss/ is the difference between !nco"e and E#penses !nco"e is made up of $e%enue .from operating activities/ and &ains .usually from non$

•

operating activities/ E#penses are outflows of resources to generate income

$elationship between the !nco"e 'tate"ent and the (alance 'heet: • • •

4he two are closely related, but 8$T substitutes for each other in any way 4he income statement can be viewed as lin6ing the balance sheet at the start of a period with the balance sheet at the end of the period 4he accounting equation can thus be extended as&

 "ssets H OE #e, 9 Profit (or  Loss) 9: $ther OE  ad; I Liabilities

or  further extended to&  "ssets H OEbeg ) (nco!e  &/enses) 9: $ther OE  ad; I Liabilities