Chapter 2: Statement of Financial Position

Overview
This course is designed to provide the learner a basic understanding of
financial statements with an emphasis on the statement of financial position or
balance sheet. This module introduces the learner to the subject, develops the
learner’s understanding of the requirements through the use of example and
indicates significant standards that are required in presenting a statement of
financial position. Furthermore, the module includes questions designed to test the
learner’s knowledge of the requirements and to develop the learner’s ability to
present a statement of financial position.

I. Objectives

At the end of this module, the learners are expected;

 To know the nature of a statement of financial position

 To understand the current and noncurrent classifications of assets and

liabilities.

 To understanding refinancing of a currently maturing debt.

 To identify the components of equity in a corporation.

 To identify the minimum line items in a statement of financial position

 To be able to prepare a statement of financial position using Philippine

format and IFRS format
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II. Learning Activities

Statement of Financial Position

A statement of financial position is a formal statement showing the three elements

comprising financial position, namely assets, liabilities and equity.

Investors, creditors and other statement users analyze the statement of financial
position to evaluate such factors as liquidity, solvency and the need of the entity
for additional financing.

Liquidity is the ability of the entity to meet currently maturing obligations.

Solvency is the availability of cash over the longer term to meet maturing
obligations.

Information about liquidity and solvency is useful in predicting the ability of the
entity to comply with future financial commitments and to pay dividends to
shareholders.

Current and noncurrent distinction

PAS 1, paragraph 60, provides that an entity shall present current and noncurrent
assets, and current and noncurrent liabilities, as separate classifications in the
statement of financial position.

When an entity supplies goods or services within a clearly identifiable operating

cycle the separate classification of current and noncurrent assets and liabilities is
a useful information.

It highlights assets that are expected to be realized within the current operating
cycle, and liabilities that are due for settlement within the same period.

For some entities, such as financial institutions, a presentation of assets and

liabilities in increasing or decreasing liquidity provides information that is
faithfully represented and more relevant.

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Assets

The Revised Conceptual Framework defines an asset as a present economic

resource controlled by the entity as a result of past events.

An economic resource is a right that has the potential to produce economic

benefits.

In layman's language and in short, assets are properties owned.

The essential characteristics of an asset are: (CPE)

a. The asset is controlled by the entity.

b. The asset is the result of a past event.
c. The asset has the potential to produce economic benefits.

Current Assets

PAS 1, paragraph 66, provides that an entity shall classify an asset as current
when:

a. The asset is cash or a cash equivalent unless the asset is restricted to settle a
liability for more than twelve months after the reporting period.
b. The entity holds the asset primarily for the purpose of trading
c. The entity expects to realize the asset within twelve months after the reporting
period.
d. The entity expects to realize the asset or intends to sell or consume it within
the entity's normal operating cycle.

Cash and Cash equivalents

This category includes cash on hand, petty cash fund, cash in bank and any cash
equivalent.

However, the cash and cash equivalent shall be unrestricted in use, meaning
available anytime for the payment of current obligations.

PAS 7, paragraph 6, defines cash equivalents as short-term, highly liquid

investments that are readily convertible into known amount of cash and which are
subject to an insignificant risk of changes in value.

Therefore, an investment normally qualifies as a cash equivalent only when it has

a short maturity of three months or less from the date of acquisition.

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Examples of cash equivalents

a. Three-month BSP treasury bill

b. Three-year BSP treasury bill purchased three months before date of maturity
c. Three-month time deposit
d. Three-month money market instrument

Note that what is important is the date of purchase which should be three months
or less before maturity.

Thus, a BSP treasury bill that was purchased three years ago cannot qualify as
each equivalent even if the remaining maturity is three months or less.

Equity securities cannot qualify as cash equivalent because shares do not have a
date of maturity.

However, preference shares with specified redemption date and acquired three
months before redemption date can qualify equivalents.

Held for trading

Appendix A of PFRS 9 provides that a financial asset is classified as held for trading
when:

a. It is acquired principally for the purpose of selling it in the near term.

b. On initial recognition, it is part of a portfolio of identified financial instruments
that are managed together and for which there is evidence of a recent actual
short-term profit taking.
c. It is a derivative, except for a derivative that is a financial guarantee contract or
a designated and an effective hedging instrument.

Simply stated, financial assets held for trading or ''trading securities" are debt and
equity securities that are purchased with the intent of selling them in the "near
term" or very soon in order to generate short-term gains or profits.

Expected to be realized within twelve months

This category refers to short-term nontrade receivables.

Nontrade receivables represent claims arising from sources other than the sale of
merchandise or services in the ordinary course of business.
Nontrade receivables are classified as current assets if collectible within one year
from the end of reporting period, the length of the operating cycle
notwithstanding.

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Otherwise, the nontrade receivables are classified as noncurrent assets.

Realized, sold or consumed

This current asset category refers to trade receivables, inventories and

prepayments.

These assets are classified as current assets because they are expected to be
realized, sold or consumed within the normal operating cycle or one year,
whichever is longer.

Operating cycle

The operating cycle of an entity is the time between the acquisition of assets for
processing and their realization in cash or cash equivalents.

When the normal operating cycle is not clearly, identifiable, the duration is
assumed to be twelve months.

The operating cycle of a trading entity is the average period of time that it
takes to acquire the merchandise inventory, sell the inventory to customers and
ultimately collect cash from the sale.

The operating cycle of a manufacturing entity is defined as the period of

time between acquisition of materials entering into a process and their realization
in cash or an instrument that is readily convertible into cash.

The normal operating cycle is significant as it is the basis of determining the proper
classification of assets into either current or noncurrent.

Presentation of current assets

Current assets are usually listed in the statement of financial position in the order
of liquidity.

PAS 1, paragraph 54 provides that as a minimum the items under current assets
are:

a. Cash and cash equivalents

b. Financial assets at fair value through profit or loss, such as trading securities
and other investments in quoted equity instruments
c. Trade and other receivables
d. Inventories
e. Prepaid expenses

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Noncurrent assets

The caption noncurrent assets is a residual definition.

PAS 1, paragraph 66, simply states that " an entity shall classify all other assets
not classified as current as noncurrent assets''.

In other words, what is not included in the definition of current assets is deemed
excluded. All others are classified as noncurrent assets. Accordingly, noncurrent
assets include the following:

a. Property, plant and equipment – refer I to AC 1

b. Long-term investments – refer to IAC 1
c. Intangible assets – refer to IAC 1
d. Other noncurrent assets – refer to IAC 1

PAS 1, paragraph 56, provides that deferred tax asset is classified as

noncurrent asset.

Liabilities

Under the Revised Conceptual Framework, a liability defined as a present

obligation of an entity to transfer an economic resource as a result of past events.

The essential characteristics of a liability are: (PTP)

a. The entity has a present obligation.

The entity liable must be identified.

It is not necessary that the payee or the entity to whom the obligation is owed be
identified.

b. The obligation is to transfer an economic resource.

This is the very heart of the definition of a liability.

Specifically, the obligation must be to pay cash, transfer noncash asset or provide
service at some future time.

c. The liability arises from past event.

This means that the liability is not recognized until it is incurred.

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Current liabilities

PAS I, paragraph 69, provides that an entity shall classify a liability as current
when:

a. The entity expects to settle the liability within the entity's normal operating
cycle.
b. The entity holds the liability primarily for the purpose of trading.
c. The liability is due to be settled within twelve months after the reporting period.
d. The entity does not have an unconditional right, to defer settlement of the
liability for at least twelve months after the reporting period.

Examples of current liabilities

a. Trade payables and accruals for employee and other operating costs are part of
the working capital used in the entity's normal operating cycle.

Such operating items are classified as current liabilities even if they are settled
more than twelve months after the end of reporting period.

b. Obligations that are not settled as part of the normal operating cycle but are
due for settlement within twelve months after the end of reporting period.

Examples of such current obligations are bank overdraft, dividends payable,

income taxes other nontrade payable and current portion of noncurrent financial
liabilities.

c. Financial liabilities held for trading are financial liabilities that are incurred with
an intention to repurchase them in the near term.

An example of a financial liability held for trading is a quoted debt instrument that
the issuer may buy back in the near term depending on changes in fair value.

Long-term debt currently maturing

PAS 1, paragraph 72, provides that a liability which is due to be settled within
twelve months after the end of reporting period is classified as current, even if:

a. The original term was for a period longer than twelve months.

b. An agreement to refinance or to reschedule payment on a long-term basis is

completed after the end of reporting period and before the financial statements
are authorized for issue.

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However, if the refinancing on a long-term basis is completed on or before the

end of the reporting period, the refinancing is an adjusting event and therefore
the obligation is classified as noncurrent.

Discretion to finance

PAS 1, paragraph 73, provides that if the entity has the discretion to refinance
or roll over an obligation for at least twelve months after the reporting period
under an existing loan facility, the obligation is classified as noncurrent even
if it would otherwise be due within a shorter period.

Note that the refinancing or rolling over must be at the discretion of the entity.

Otherwise, if the refinancing or rolling over is not at the discretion of ihe entity,
the obligation is classified as a current liability.

Covenants

Covenants are often attached to borrowing agreements which represent

undertakings by the borrower.

These covenants are actually restrictions on the borrower as to undertaking further

borrowings, paying dividends, maintaining specified level of working capital and
so forth.

Under these covenants, if certain conditions relating to the borrower's financial

situation are breached, the liability becomes payable on demand .

PAS 1, paragraph 74, states that such a liability is classified as current even if the
lender has agreed, after the end of reporting period and before the statements
are authorized for issue, not to demand payment. as a consequence of the breach.

However, Paragraph 75 states that the liability is classified as noncurrent if the

lender has agreed on or before the end of reporting period to provide a grace
period ending at least twelve months after the end of reporting period.

In this context, the grace period is a period within which the borrower can rectify
the breach and during which the lender cannot demand immediate payment.

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Presentation of Current liabilities

PAS 1, paragraph 54, provides that as a minimum, the face of the statement of
financial position shall include the following line items for current liabilities:

a. Trade and other payables

b. Current provisions
c. Short-term borrowing
d. Current portion of long-term debt
e. Current tax liability

The term "trade and other payables" is a line item for accounts payable, notes
payable, accrued interest on note payable, dividends payable and accrued
expenses.

No objection can be raised if the trade accounts and notes payables are separately
presented.

Noncurrent liabilities

The term non-current liabilities is a residual definition.

PAS 1, paragraph 69, simply states that all liabilities not classified as current
liabilities are classified as noncurrent

Examples of noncurrent liabilities:

a. Noncurrent portion of long-term debt

b. Lease liability
c. Deferred tax liability
d. Long-term obligations to entity officers
e. Long-term deferred revenue

PAS 1, paragraph 56, provides that deferred tax liability is classified as

noncurrent liability.

Working capital

The entity's liquidity is of primary concern to most statement users and this can
be properly evaluated through the current and noncurrent classifications.

For example, working capital is the excess of current assets over current
liabilities and the working capital ratio is current assets divided by current liabilities.

Estimated liabilities

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Estimated liabilities are obligations which exist at the end of reporting period
although the amount is not definite.

In many cases, the date when it is due or payable is not also definite and in some
instances, the exact payee cannot he identified or determined.

Common examples of estimated liabilities include estimated liability for premiums,

estimated liability for warranties and estimated liability under customer loyalty
program.

Estimated liabilities may be classified either as current or noncurrent.

Contingent liability

PAS 37, paragraph 10, defines a contingent liability in two ways:

A contingent liability is a possible obligation that arises from past event and
whose existence will he confirmed only by the occurrence or nonoccurrence of one
or more uncertain future events not wholly within the control of the entity.

A contingent liability is a present obligation that arises from past event but is
not recognized because:

a. It is not probable that an outflow of resources embodying economic benefits

will be required to settle the obligations.

b. The amount of the obligation cannot be measured reliably.

Range of outcome

a. Probable

The future event is likely to occur. As a rule of thumb, probable means more than
50% likely.

b. Possible

The future event is less likely to occur. The occurrence is 50% or less.

c. Remote

The future event is least likely to occur or the chance of the future event occurring
is very slight. The occurrence is 10 % or less.

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Treatment of contingent liability

A contingent liability is not recognized in the financial statements. A contingent

liability shall be disclosed only.

The required disclosures are:

1. Brief description of the nature of contingent liability

2. An estimate of the financial effects
3. An indication of the uncertainties that exist
4. Possibility of any reimbursement

If the contingent liability is remote, no disclosure is necessary.

If the present obligation, is probable and the amount can be measured reliably,
the obligation is not a contingent liability but shall be recognized as a
provision.

An expense and estimated liability shall be recorded in recognizing a provision.

Thus a contingent liability is either probable or measurable but not both.

Contingent Asset

PAS 37, paragraph 10, defines contingent asset as possible asset that arises
from past event and whose existence will be confirmed only by the occurrence or
nonoccurrence of one or more uncertain future events not wholly within the control
of the entity.

Contingent assets usually arise from unplanned or other unexpected events that
give rise to the possibility of an inflow of economic benefits to the entity.

An example is a claim that an entity is pursuing through legal processes when the
outcome is uncertain.

Treatment of contingent asset

A contingent asset shall not be recognized because this may result to recognition
of income that may never be realized.

However, when the realization of income is virtually certain, the related asset is
no longer contingent asset and its recognition is appropriate.

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The outcome of a contingent asset is reported as follows:

a. A contingent asset is recognized in the period when realized

b. A contingent asset is only disclosed when it is probable.

c. If the contingent asset is possible, no disclosure is required.

d If the contingent asset is remote, no disclosure is required

Equity

The term equity is the residual interest in the assets of the entity after deducting
all of the liabilities.

Simply stated, equity means net assets or, total assets minus liabilities.

Equity is increased by profitable operations and contributions by owners.

Conversely, equity is decreased by unprofitable operations and distribution to

owners.

The terms used in reporting the equity of an entity depending on the form of the
entity are:

a. Owner's equity in a proprietorship

b. Partners' equity in a partnership
c. Shareholder& equity in a corporation

However, the term equity may simply be used for all business entities.

Shareholders’ equity

Shareholders' equity or stockholders' equity is the residual interest of owners

in the net assets of a corporation measured by the excess of assets over
liabilities.

Generally, the elements constituting shareholders' equity with their equivalent

IAS term are:

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Line Items of Statement of Financial Position

PAS 1, paragraph 54, states that as a minimum, the statement of financial

position shall include the following line items:

1. Cash and cash equivalents

2. Financial Assets (other than 1, 3 and 6)
3. Trade and other receivables
4. Inventories
5. Property, plant and equipment
6. Investment in associates using the equity method
7. Intangible assets
8. Investment property
9. Biological Assets
10. Total of assets classified as held for sale and assets included in disposal group
classified as held for sale
11. Trade and other payables
12. Current tax asset and liability
13. Deferred tax asset and deferred tax liability
14. Provisions
15. Financial Liabilities
16. Liabilities included in disposal group held for sale
17. Noncontrolling interest
18. Share capital and reserves

The listing of line of the line items is not exclusive.

Paragraph 54 simply provides a list of items that are sufficiently different in nature
and function to warrant separate presentation on the face of the statement of
financial position.

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Paragraph 55 provides that additional line items, headings and subtotals shall be
presented on the face of the statement of financial position when such
presentation is relevant to the understanding of the financial position of an entity.

The judgment on whether additional line items are presented separately is based
on the assessment of the following:

a. Nature and liquidity of assets

b. Function of assets within the entity
c. Amount, nature and timing of liabilities

Forms of statement of financial position

The format of a statement of financial position is not specified in PAS 1.

In, practice, there are two customary forms in presenting the statement of financial
position, namely:

a. Report Form

This form sets forth the three major sections in a downward sequence of assets,
liabilities and equity.

b. Account form

As the title suggests, the presentation follows that of an account, meaning, the
assets are shown on the left side and the liabilities and equity on the right side of
the statement of financial position.

Actually, the statement of financial position is an expansion of the accounting

equation "asset equals liability plus equity".

PAS I, paragraph 57, provides that the standard does not prescribe the order or
format in which line items are to be presented,

In the Philippines, the common practice is to present in the statement of

financial position current assets before noncurrent assets, current liabilities before
noncurrent liabilities, and equity after liabilities.

Other formats may be equally appropriate provided the distinction is clear in

accordance with paragraph 7 of the Preface to IAS 1.

Note that the format of the statement of financial position as illustrated in the
appendix to IAS 1 is in the following order :

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Noncurrent assets
Current assets
Equity
Noncurrent liabilities
Current liabilities

This may be the practice in other jurisdiction, like the United Kingdom.

Illustration – Report form

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Illustration – Account form

Illustration – United Kingdom Style

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III. Assessment:

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Theory: Write your answer in yellow paper.

1. Define a statement of financial position.

2. Explain the presentation of assets and liabilities in the statement of financial
position.
3. Define assets.
4. What are the essential characteristics of assets?
5. Define current assets.
6. Explain briefly an operating cycle.
7. What are the line items that should be shown under current assets on the face
of the statement of financial position?
8. Define noncurrent assets.
9. Define property, plant and equipment.
10. Define investments.
11. Define intangible assets.
12. Define other noncurrent assets.
13. Define liabilities.
14. What are the essential characteristics of liabilities?
15. Define current liabilities.
16. Explain fully the treatment of currently maturing long-term debt.
17. What are covenants?
18. Explain the classification of a liability if the related covenants are breached.
19. What are the line items that should be shown under current liabilities on the
statement of financial position?
20. Define noncurrent liabilities.
21. What is working capital?
22. What are estimated liabilities?
23. Define a contingent liability.
24. Explain the treatment of a contingent liability.
25. Define a contingent asset.
26. Explain the treatment of a contingent asset.
27. Define equity.
28. What are the components of shareholders' equity?
29. Explain share capital, subscribed share capital and share premium.
30. Explain treasury shares.
31. Explain retained earnings.
32. Explain revaluation surplus.
33. Discuss the meaning of the term reserves.
34. What are the line items that are required to be shown on the face of the
statement of financial position?
35. Explain the forms of statement of financial position,

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Problems: Write your answer and solutions to yellow paper.

Use Report form

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Use Account Form

Deadline: October 20, 2020, Tuesday at 12nn. Send your activity to the representative
of the class.
References: Financial Accounting 3 by: Valix 2019 edition

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