1. Assets, liabilities and the business entity concept Flashcards
Define an Asset.
The Conceptual Framework states that ‘an asset is a present economic resource controlled by the entity as a result of a past event. An economic resource is a right that has the potential to produce economic benefits.’ (Conceptual Framework: paras. 4.3 and 4.4)
Give examples of assets you would find in financial statements. (8)
- Land and buildings: factories, office buildings, storage and distribution centres (warehouses)
- Motor vehicles
- Plant and machinery
- Fixtures and fittings: computer equipment, office furniture and shelving
- Software, capitalised development costs, licenses quotas (known as intangible assets)
- Cash: in a bank account or held as notes and coins
- Inventory: goods held in a store awaiting sale to customers, and raw materials and components held in store by a manufacturing business for use in production
- Receivables: amounts owed by customers and others to the entity
What is the distinction between current and non-current assets.
Non-current assets are those that are expected to generate economic benefits over a number of years.
Short term assets are called current assets.
Define a Liability.
The Conceptual Framework states that a ‘liability is a present obligation of the entity to transfer an economic resources as a result of past events.’ (Conceptual Framework: para. 4.26)
Give examples of liabilities likely to be found in the financial statements.
- A bank loan or overdraft: the liability is the amount eventually repaid to the bank.
- Payables: amounts owed to suppliers for goods purchased but not yet paid for (purchases ‘on credit’). For example, a boat builder buys some timber on credit from a timber merchant, so that the boatbuilder does not pay for the timber until some time after it has been delivered. Until the boatbuilder pays what he owes, the timber merchant is a creditor for the amount owed.
- Taxation owed to the government: A business pays tax on its profits but there is a gap in time between when a business declares its profits (and becomes liable to pay tax) and the payment date.
What is the distinction between current and non-current liabilities?
Liabilities for which economics assets are expected to be transferred in the next 12 months are current.
Liabilities for which economic resources are expected to be transferred in more than 12 months are non-current.
How does leased property appear in the financial statements?
If an asset is leased and recognised on the statement of financial position, a corresponding lease liability is also recognised.
The amount repayable in the next 12 months will be shown as a current liability with the remainder as a non-current liability.
Explain the concept of ‘the business as a separate entity’ in the context of a limited liability company.
The law recognises a limited liability company as a legal entity, quite separate from its owners.
A company may, in its own name, acquire assets, incur debts, and enter into contracts.
If a company’s assets became insufficient to meet its liabilities, the company as a separate entity becomes ‘insolvent’. However, the owners of the company are not usually required to pay the debts from their own private resources: the debts are not debts of the owners, but of the company.
Explain the concept of ‘the business as a separate entity’ in the context of a sole trader or a limited liability partnership.
There is no legal separation between a sole trader and the business he/she runs.
In most partnerships there is no legal distinction. A limited liability partnership (LLP) is a hybrid form of business entity in that it is a separate legal entity, like a company, therefore each partner (member) of the LLP has limited liability, however, it does not have shareholders and has other characteristics of a partnership.
How does the Accounting view of the ‘business as a separate entity’ differ from the legal view?
What is the concept called?
In accounting, any business is treated as a separate entity from its owners.
This applies whether or not the business is recognised in law as a separate, ie, it applies whether the business is carried on by a company or by a sole trader.
This is known as the business entity concept (or separate entity concept, or just entity concept).
What is the business entity concept?
The concept that a business is a separate entity from its owner.
Although this may seem illogical, it is the basis of a fundamental rule of accounting, which is that liabilities plus the equity of the business must always equal its assets.
Example of the ‘Business Entity Concept’
On 1 July 20X6, Charlie opened a flower stall. They had saved £2,500 and opened a business bank account with this amount.
When the business commences, as an accountant’s picture can be drawn of what it owns and what it owes. The business begins by owning the cash that Charlie has put into it, £2,500.
The business is a separate entity in accounting terms. It has obtained assets, in this example cash, from Charlie. It therefore owes this amount of money to Charlie. If Charlie changed their mind and decided not to go into business, the business would be dissolved by the ‘repayment’ of cash to Charlie.
What is the definition of Capital?
The Conceptual Framework states that capital (which it calls equity in the context of a company) is the ‘residual interest in the assets of the entity after deducting all its liabilities.’ (Conceptual Framework: para. 4.63)
In simple terms, capital can be viewed as a measure of the owner’s investment in the business.
