2. Statement of Financial Position (Balance Sheet)

Question 1

What is the accounting equation?

Answer 1

Assets = Liabilities + Equity

This must be satisfied in the SoFP.

This is done through double-entry bookkeeping (recording the effect of a transaction through at least two accounting entries).

e.g., Business buys inventory on credit:
A (+ inventory) = L (+ payables) + E

Question 2

What is equity?

Answer 2

The owners’ residual claim on the assets of the company.
Equity = Assets - Liabilities
Equity = Share capital + Retained earnings

Question 3

What is an asset?

Answer 3

A present economic resource controlled (not necessarily owned) by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.
This includes items owned by the company, amounts owed to the company, and services and goods owed to the company (those that it has paid suppliers for in advance).

Question 4

What are the IFRS’ requirements for an asset to be recognised (included in the SoFP)?

Answer 4

The asset must:
- Have a future economic benefit to the firm.
- Be controlled by the firm. In many cases, but not all, this will involve ownership of the asset.
- Have a measurable value (or cost). Items that do not have a quantified value cannot be included in the financial statements.

Question 5

What is one of financial accounting’s most important limitations created by IFRS’ asset recognition conditions?

Answer 5

The SoFP excludes assets that are economic resources of the firm BUT whose cost or value cannot be measured with reliability or fail the control requirement (e.g. human capital or internally generated intangible assets).

Question 6

What is missing from the balance sheet that seriously undermines its usefulness?

Answer 6

The following assets are excluded from the SoFP due to the IFRS’ asset recognition requirements:
- Human resources: Most valuable resource of many firms. Companies do not own or control people. One exclusion is the transfer or registration of professional sportspeople.
- Internally developed intangible assets. Most intangible assets can only be recognised if purchased but cannot if internally developed. Thus, the book value of technology firms is often understated (and hence so is the reported value for their equity).

Question 7

What are current assets? What are examples of current assets?

Answer 7

Assets that the firm is due to receive or intends to sell or consume within the next 12 months.
- Cash and cash equivalents and any other financial assets that the firm is due to receive within 12 months.
- Inventory (a.k.a. stock): raw materials, work-in-progress and finished goods.
- Trade receivables: amounts owed by customers (invoiced)
- Accrued income: amounts owed by customers (not yet invoiced)
- Prepayments: asset that represents the value of goods paid for in advance.
- Prepaid expenses: asset that represents the value of services paid for in advance.