2 Balance Sheets

Question 1

What is a balance sheet?

Answer 1

A financial statement that presents the relationship between an entity’s assets. liabilities and equity at a point in time.

Question 2

What is de-recognition?

Answer 2

When an item no longer meets the definition of an asset or a liability so we no longer recognise it on the financial statements.

Question 3

What are the two types of value measurement?
Which does the IASB promote?

Answer 3

▪ Historical cost basis
▪ Current value basis

A mixed approach, depending on business activities. Most often current value, if it is a manufacturing firm for example.

Question 4

What is historical cost measurement?

Answer 4

Historical cost measures the cost of an asset when it was bought. When they are recorded, they are depreciated on the balance sheet (adjusted for current value).

Question 5

What are some pros of historical cost accounting?

Answer 5

▪ verifiable
▪ tracks the impact on financial position at that point in time (expenses)
▪ tracks the process of purchasing and using an asset
▪ can analyse the benefit of an asset (after its use)

Question 6

What are the sub-types of current value approaches?

Answer 6

▪ Current cost
▪ Fair value
▪ Value in use/fulfilment value

Question 7

What is current cost measurement?

Answer 7

The cost of acquiring the asset in the current market conditions. The cost of the item plus any transaction costs.

Question 8

What is fair value measurement?

Answer 8

The current market value of an item if the entity was to sell it (at measurement date). Assumes there is a market for the item.

Question 9

What is value in use/fulfilment value measurement?

Answer 9

The value of an asset to the firm through its operation/output. Entity-specific values.

Question 10

How are fair value measurements further subcategorised?
What are these subcategories?

Answer 10

The higher the level, the less subjective (more reliable) the data is:
Level 1: quoted prices in active markets of identical assets/liabilities.
Level 2: inputs other than quoted prices that are observable.
Level 3: inputs not based on observable market data, but reflecting market assumptions.

Question 11

What does going concern mean?

Answer 11

That a company has the resources needed to continue operating indefinitely until it provides evidence to the contrary.

Question 12

What does PPE mean in accounting?
What are they used for?

Answer 12

Property, plant and equipment.
Tangible resources used in production, for rental to others, or other admin purposes. They are expected to be used during more than one financial year.

Question 13

What does of PPE comprise of?

Answer 13

All costs *directly attributable* to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by the business.

Question 14

What are the two models of measuring PPE? How are they calculated?

Answer 14

Cost Model:
Carrying amount = cost - accumulated depreciation - accumulated impairment losses

Revaluation Model:
Carrying amount = fair value (at date of revaluation) - accumulated depreciation - accumulated impairment losses

Question 15

What are the most common depreciation methods?
How are they chosen?

Answer 15

▪ Straight-line method
▪ Reducing balance method

The method is chosen by the firm, it should reflect the pattern in which the asset’s future economic benefits are expected to be consumed.

Question 16

How are “lower of” and “higher of” used in impairment?

Answer 16

Lower of: carrying amount and recoverable amount
Higher of: value in use, fair value less costs to sell (which account for recoverable amount)

Question 17

When is an asset impaired?
What is recognised?

Answer 17

If recoverable amount < carrying amount, the asset is impaired - an impairment loss is recognised:
Dr impairment loss
Cr Asset

Question 18

How often to companies recognise impairment?

Answer 18

At the end of each fiscal year, a company must assess any indicators and carry out impairment tests.

Question 19

What are some external indicators of impairment?

Answer 19

▪ Market value declines for specific assets
▪ Significant adversechanges in the business, technological, market, economic or legal environment where assets are used (e.g. in recessionary times)
▪ Increases in market interest rates (affects value in use)

Question 20

What are some internal indicators of impairment?

Answer 20

▪ Obsolesce or physical damage to an asset
▪ Significant internal changes to a company’s operations
▪ Indicators that the economic performance of an asset is (or will become) worse than previously anticipated
▪ Idle assets
▪ Change of use of an asset

Question 21

What are intangible assets?

Answer 21

Identifiable non-monetary assets without physical substance.

Question 22

What are common characteristics of intangible assets?

Answer 22

▪ Intrinsically tied to the value of the business.
▪ Intrinsically tied to the value of business, difficult to identify cost related to asset.
▪ Uniqueness.
▪ Less defined property rights.

Question 23

What conditions must be met for intangible assets to be recognised?

Answer 23

▪ Probable flow of economic benefits (judgement needed).
▪ Reliable measurement.
▪ Identifiable (and separate from other assets).

Question 24

How are intangible assets measured compared to PPE?

Answer 24

Similar treatment.
Cost and revaluation models (the latter is rare).

Question 25

What happens if we can estimate the useful life of an intangible?

What happens if we cannot?

Answer 25

If useful life is estimated, amortisation (instead of depreciation) is required - residual value is presumed to be zero.

If we cannot, we assume it has an indefinite life (not infinite). No amortisation, instead we test impairment yearly.

Question 26

What are inventories and types?

Answer 26

Inventories are current assets:
▪ held for sale for operation (finished goods).
▪ in the process of production for sale (work-in-progress).
▪ in the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials).

Question 27

How are inventories measured?

Answer 27

Inventories are measured at the lower of cost and net realisable value (NRV)

Question 28

What does NRV mean?

Answer 28

Net Realisable Value - estimated selling price less estimated costs of completion and estimated costs necessary to make the sale - e.g. marketing and distribution.

Question 29

Why might there be a discrepancy between NRV and cost?

Answer 29

▪ Permanent fall in market price of inventory
▪ Deliberate decision to dispose of high inventory levels
▪ Physical deterioration
▪ Product obsolescence
▪ Deliberate decision to sell “below cost” as marketing strategy

Question 30

What are provisions?

Answer 30

Subset of liabilities of uncertain timing or amount.

Question 31

When should provisions be recognised?

Answer 31

▪ an entity has a present obligation as a result of a past event
▪ it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation
▪ a reliable estimate can be made of the amount of the obligation

Question 32

What are the types of obligations for provisions?

Answer 32

Legal obligation- deriving from contract legislation, or other operation of law
Constructive obligation- deriving from an entity’s actions where:
▪ established pattern of past practice
▪ a valid expectation has been created

Question 33

When should an outflow of resources be regarded as probable? (provisions)

In which case, how would we value this outflow?

Answer 33

The probability of an event happening is greater than the probability that it won’t.

A reliable estimate is required- best estimate of what an entity would rationally pay to settle the obligation.

Question 34

Examples of provisions

Answer 34

▪ Bad debt
▪ Warranties
▪ Environmental damages
▪ Restructuring
▪ Onerous contracts

Question 35

What are contingent liabilities?

Answer 35

A *possible* obligation arising from past events, which will only be confirmed by the occurrence of uncertain future events- not in the entity’s control.
OR
A present obligation, not recognised because it is not probable that an outflow of resources will be needed to settle it, or the measurement is unreliable.

Question 36

Where are contingent liabilities disclosed?

Why do they need to be disclosed?

Answer 36

NOT included on the balance sheet, but *may* need to be disclosed in the notes.

Disclosed for:
▪ full disclosure
▪ materiality
▪ prudence

Question 37

What examples can we give for contingent liabilities?

Answer 37

▪ Product warranty
▪ Lawsuits

Question 38

Define economic resource

Answer 38

An economic resource is a right (legal or constructive) that has the potential to produce economic benefit.

Question 39

Straight line depreciation formula

Answer 39

Depreciation per year = (cost of asset - salvage value)/Useful like of asset

Question 40

Reducing balance depreciation formula

Answer 40

DB rate = 1 - n√(salvage value/cost)
^ NB: the nth root not n multiplied by the root.

Question 41

Fair view and PPE inclusion

Answer 41

For a fair view of a company’s resources, PPE should not be included in the statement of financial position at amounts in excess of amounts expected to be recovered in future periods.

Question 42

Depreciation and the accrual principal

Answer 42

In line with accrual principal - depreciation is systematically allocated over the asset’s useful life (except land).

Assets that are recognised separately are depreciated separately.

Question 43

What are fixed assets?

Answer 43

These assets represent the infrastructure of the organisation and are held over the long term. They are employed in the organisation to generate revenue over multiple reporting periods. Such examples are equipments and stores.

Question 44

What are current assets?

Answer 44

These assets are held over the short term and are part of the organisation’s trading cycle. These are more dynamic than fixed assets. Such examples include cash and inventory as well as accounts receivable, which is the amount owed to the organisation.

Question 45

What are long-term liabilities?

Answer 45

Liabilities that are expected to be paid more than a year after the balance sheet date. Such as mortgages or bank loans.

Question 46

What are current liabilities?

Answer 46

Liabilities that are expected to be paid within a year of the balance sheet date. They include taxes and short-term loans as well as accounts payable, which is the amount the organisation owes.

Question 47

How are entries on the balance sheet organised?

Answer 47

Assets and liabilities organised in terms of liquidity; start with the most illiquid down to most liquid.

Question 48

Why does liquidity matter to an organisation?

(2)

Answer 48

1. An organisation must have sufficiently liquid assets to cover to meet its obligation when they fall due.
2. Greater liquidity implies greater flexibility and is better able to cope with changes to the economic climate.

Question 49

Albert has 5k worth of cash, 30k worth of equipment and 15k worth of bank loans.

Construct a balance sheet.

Answer 49

Question 50

Albert has 15k cash, 27k equipment, 4k inventory, 7k accounts payable, 15k bank loan, 3k tax payable, 6k accounts receivable.

Construct a balance sheet.

Answer 50