Accounting for Business

Chapter 2: The Statement of Financial

Position

© Peter Scott, 2019. All rights reserved.

 The Statement of Financial Position
A summary in money terms of:
• Assets an organization controls and
• Liabilities an organization owes to outside
parties

• Also known as the Balance Sheet

© Peter Scott, 2019. All rights reserved.

 Definitions: Assets (1)
IASB Conceptual Framework for Financial Reporting
definitions:
• “A present economic resource
• controlled by the entity
• as a result of past events.” (paragraph 4.3)

“An economic resource is a right that has the potential

to produce economic benefits.” (paragraph 4.4)
What do these IASB definitions mean?

© Peter Scott, 2019. All rights reserved.

 Definitions: Assets (2)
• Control: a resource owned or leased by an entity
which can enforce its legal rights over that
resource
• As a result of past events: signing a contract or
paying money to acquire the right to use an asset
• Present: the resource must be under the entity’s
control at the statement of financial position date
• Economic benefits: resources are used within the
entity to generate profits and cash
An asset thus represents a store of potential
economic benefits to be realised in the future
© Peter Scott, 2019. All rights reserved.
 Definitions: Assets (3)
• Assets and liabilities can only be recognized in
financial statements when their monetary value can
be faithfully represented
• Faithful representation = monetary values that are
complete, neutral and free from error
• Estimates of monetary values can be used when no
actual cost figure is available, BUT
• Estimates are subject to measurement uncertainty
• When measurement uncertainty is so high that a
faithful representation cannot be achieved, no asset
is recognized
© Peter Scott, 2019. All rights reserved.
 Summary of Asset Recognition Steps

© Peter Scott, 2019. All rights reserved.

 Non-Current Assets: Definition
• Not purchased for resale in the normal course of
business
• Retained within the business for periods of more
than one year
• Not acquired with the intention of reselling them
immediately or in the near future
• Held for long-term use in the business to produce
goods or services

© Peter Scott, 2019. All rights reserved.

 Non-Current Assets: Examples
• Intangible assets: no material substance.
Examples: goodwill, patents, trademarks,
intellectual property rights
• Tangible assets: property, plant and equipment.
Examples: buildings, vehicles, machinery,
computers, fixtures and fittings
• Investments: shares or other financial assets (such
as loans) in other business entities

© Peter Scott, 2019. All rights reserved.

 Current Assets
• Short-term assets which are constantly changing
• Inventory: a stock of goods for production or
resale, a store of potential cash
• Receivables: amounts owed by outside parties to
the business for goods supplied on credit, the right
to receive cash in the future
• Cash and cash equivalents: cash in hand, money
in bank accounts or on deposit

© Peter Scott, 2019. All rights reserved.

 Non-Current and Current Assets
• The distinction between the two types of assets is
one of time
• Non-current assets provide benefits over more
than one year
• Current assets are held only for a short time to
generate cash which is then used to buy more
goods for production or resale
• Distinction will also depend on the business in
which an entity is engaged

© Peter Scott, 2019. All rights reserved.

 Definitions: Liabilities (1)
IASB Conceptual Framework for Financial Reporting
definition:
• “A present obligation of the entity
• to transfer an economic resource
• as a result of past events.” (paragraph 4.26)
The term economic resource is defined in exactly the
same way as before.
What does the IASB definition of a liability mean?

© Peter Scott, 2019. All rights reserved.

 Definitions: Liabilities (2)
• Liabilities represent the contractual or legal claims
of outside parties against an entity
• Present obligation: the obligation must exist at the
statement of financial position date to be recognized
in the SoFP
• Economic resource: usually the transfer of cash to
an outside party
• As a result of past events: such as borrowing money
which has to be repaid or receiving goods or
services which have to be paid for at a later date
© Peter Scott, 2019. All rights reserved.
 Definitions: Liabilities (3)
• To qualify as a liability the obligation must be
unavoidable
• Just as in the case of assets, liabilities can only be
recognized in financial statements when their
monetary value can be faithfully represented
• Where the required standard of faithful
representation is not met, no liability is recognized
in the statement of financial position

© Peter Scott, 2019. All rights reserved.

 Summary of Liability Recognition Steps

© Peter Scott, 2019. All rights reserved.

 Non-Current Liabilities
Non-current liabilities are due for settlement in more
than12 months time.

Examples
• Loans due to be repaid after more than one year
• Retirement benefits
• Long-term provisions

© Peter Scott, 2019. All rights reserved.

 Current Liabilities
Due for settlement over the course of the next 12
months

Examples
• Instalments on long-term loans that are repayable
over the course of the next year
• Amounts due to suppliers (trade payables)
• Tax payable on the profits of the last trading period

© Peter Scott, 2019. All rights reserved.

 The Accounting Equation
Either:

Total Assets = Total Liabilities + Capital

Or

Total Assets – Total Liabilities = Capital

The two totals should be equal so that the statement of

financial position balances

© Peter Scott, 2019. All rights reserved.

 Equity: Definition
IASB Conceptual Framework for Financial Reporting
paragraph 4.63 definition:
• “The residual interest in the assets of the entity
after deducting all its liabilities” IE Total assets –
total liabilities = equity (capital)
• In theory, the cash that would be left if all the
assets of the entity were sold and all the liabilities
settled at their statement of financial position
amounts
• This cash would then belong to the owners of the
entity
© Peter Scott, 2019. All rights reserved.
 Equity: Components (1)
Public Limited and Limited Companies:
• Share capital: number of shares in issue x the par
(face or nominal) value of each share
• Share premium: the amount received on shares
issued over and above the par value
• Retained earnings: profits of the business not yet
distributed to shareholders as dividends
• Any other reserves

© Peter Scott, 2019. All rights reserved.

 Equity: Components (2)
Sole Traders and Partnerships:
• Capital at the start of the year +
• Capital introduced (the owner(s) own money)
during the year +
• Retained profits for the year –
• Retained losses for the year –
• Capital withdrawn (drawings): cash taken out of the
business by the owner(s) during the year, a
repayment of the owner’s investment

© Peter Scott, 2019. All rights reserved.

 Drawing Up The Statement of Financial Position
• Step 1: Decide whether each balance is an asset, a
liability or an element of equity
• Step 2: Categorize assets and liabilities as current
or non-current
• Step 3: Add together balances that fall under the
same statement of financial position heading: e.g.
cash in hand and cash at bank
• Step 4: Enter balances against the relevant
headings in the statement of financial position

© Peter Scott, 2019. All rights reserved.

 Valuing Assets and Liabilities
• Assets and liabilities are usually valued at their
original cost
• Original cost = historic cost
• The historic cost convention has now been relaxed
• So that it is possible to value assets and liabilities
at either cost or fair value

© Peter Scott, 2019. All rights reserved.

 Fair Value
• Fair value = market value
• Fair value: assets: the amount at which an asset
could be sold in the open market
• Fair value: liabilities: the amount at which a liability
could be settled in the open market
• Fair value option rarely used other than for land
and buildings
• However, IASB rules state investments must be
valued at fair value

© Peter Scott, 2019. All rights reserved.

 Historic Cost v Fair Value: Problems
• Historic cost: objective valuation verifiable by
reference to a transaction cost at a fixed point in
time
• Therefore, historic costs of long-term assets
gradually become more and more out of date
• Meaning that these costs become less and less
relevant for decision making
• Fair value: up to date valuations
• Mixture of historic cost and fair value can cause
confusion to financial statement users
© Peter Scott, 2019. All rights reserved.
 What the SoFP Does Show
• The SoFP shows the financial position of an entity
on the last day of its accounting year
• This is a snapshot of the entity at one point in time
• A totally different view would be given if the
snapshot were to be taken on any other day
• The SoFP shows financially measureable
resources (assets) and financially measureable
obligations (liabilities) of an entity

© Peter Scott, 2019. All rights reserved.

 What the SoFP Does Not Show
• All the assets of the organization: missing assets
include employee knowledge and skills, goodwill,
brands and traditions
• All the liabilities of the business: missing liabilities
include costs for environmental damage and claims
against the organization that are not known by the
year end
• The market value of an organization: this is
determined by what a third party would pay to
acquire the organization

© Peter Scott, 2019. All rights reserved.

 Dual Aspect Concept
• Transactions have a double effect on figures in the
statement of financial position
• E.g.: Buy more inventory for cash: inventory goes
up, cash goes down
• Accountants use the term “double entry”, as two
account balances are affected by each new
transaction
• Accounting terminology: debits and credits

© Peter Scott, 2019. All rights reserved.