4. The Statement of Financial Position

Question 1

What is the statement of financial position?

Answer 1

The business’s statement of financial statement position shows its liabilities, capital and assets at a point in time.

It is a ‘financial snapshot’ of he position of the business at the end of the reporting period to which the financial statements relate.

Question 2

What are the differences between the statement of financial position and an accounting equation? (2)

Answer 2

1. The manner or format in which the liabilities and assets are presented.
2. The extra detail which is usually contained in the statement of financial position.

Question 3

How is the statement of financial position presented? (2)

Answer 3

A statement of financial position is divided into two halves, and is presented in either of the following ways:
1. Capital and liabilities in one half and assets in the other (the IAS 1 format adopted in the workbook)
2. Capital in one half and net assets in the other (the UK GAAP format for the balance sheet is looked at in chapters 14 and 15)

Question 4

Define net assets.

Answer 4

Assets less liabilities.

Question 5

Which two types of asset are found the in the statement of financial position?

Answer 5

The statement of financial position distinguishes between non-current assets and current assets.

Non-current assets are acquired for long-term use within the business. They are normally carried at cost less accumulated depreciation.

Current assets are expected to be converted into cash within one year.

Question 6

What is a non-current asset?

Answer 6

Non-current assets are assets acquired for continuing use within the business, with a view to earning income or making profits from their use, either directly or indirectly, over more than one reporting period.

Question 7

What are non-current assets in the statement of financial position?

Answer 7

Non-current assets in the statement of financial position usually comprise:
1. Property, plant and equipment (i.e. ‘tangible’ assets)
2. Right of use assets
3. Intangible assets such as patents and licenses
4. Long-term investments

Question 8

Give three examples of non-current assets.

Answer 8

A non-current asset is not acquired for sale to a customer.

1. In a manufacturing industry, a production machine is a non-current asset, because it makes goods which are then sold.
2. In a service industry, equipment used by employees giving service to customers is a non-current asset (e.g. the equipment used in a garage, or furniture in a hotel).
3. Less obviously, factory premises, office furniture, computer equipment, company cars, delivery vans or pallets in a warehouse are all non-current assets.

Question 9

What two conditions must an item satisfy to be classed as a non-current asset in the statement of financial position?

Answer 9

1. It must be used by the business. For example, the owner’s own house would not normally appear on the business statement of financial position.
2. The asset must have a ‘life’ in use of more than one reporting period or year.

Question 10

What is the distinction between tangible and intangible non-current assets?

Answer 10

A tangible non-current asset is a physical asset that can be touched. They are often referred to as property, plant and equipment.

Intangible non-current assets do not have a physical existence; they cannot be touched. Examples are a patent, which protects an idea and, a licence, which permits the holder to operate in a certain area or use an asset in a particular way.

Question 11

How would an investment be recorded in the statement of financial position?

Answer 11

An investment can also be a non-current. Company A might invest in another company, B, by purchasing some of B’s shares.

These investments will earn income for A in the form of dividends paid out by B. If the investments are purchased by A with a view to holding on to them for more than one year, they would be classified as non-current assets of A.

Question 12

What is the ‘useful life’ of an asset?

What is the exception to the concept of ‘useful life’?

Answer 12

Non-current assets are held and used by a business for a number of years, but they wear out or lose their usefulness in the course of time.

Every tangible non-current asset has a limited life, known as the ‘useful life’ to the business. This is not necessarily the same as the total life of the asset.

For example, a well maintained car might expect to have total life of ten years but, if a business plans to replace the car after five years, its useful life to the business is only five years.

The exception to having a useful life is freehold land, although this too can be exhausted if it is used by extractive industries (e.g., mining).

Question 13

What is depreciation?

Answer 13

The financial statements of a business reflect that the cost of a non-current asset is gradually consumed as the asset is used over its useful life.

This is done by gradually ‘writing off’ the asset’s cost in the statement of profit or loss over several reporting periods.

For example, in the case of a machine costing £1,000 and expected to wear out after 10 years, it is appropriate to reduce the value of statement of financial position by £100 each year.

If a statement of financial position were drawn up four years after the asset was purchased, the amount of depreciation accumulated over four years would would be 4 x £100 = £400.

Question 14

What form do current assets take? (2)

Answer 14

Current assets take one of the following two forms:
1. Items owned by the business with the intention of turning them into cash in a short time, usually within one year.
2. Cash, including money in the bank, owned by the business.

These assets are ‘current’ in the sense that they are continually flowing through the business; they are always realisable in the near future.

Question 15

Define current asset.

Answer 15

An asset is current when it is expected to be realised in, or intended for sale or consumption in, the entity’s normal operating cycle, or it is held for being traded, or it is expected to be realised within 12 months of the date of the statement of financial position, or it is cash or a cash equivalent.

Question 16

How do the following appear in the statemen of financial position:
1. Inventory
2. Trade and other receivables
3. Cash

Answer 16

1. Inventory for resale are current assets as it is intended to be sold within one year in the normal course of trade.
2. Trade and other receivables are current assets, if they will be paid within the usual cash operating cycle of less than one year.
3. Cash is a current asset.

Question 17

Is an investment a current or non-current asset?

Answer 17

The classification of the investment will depend on the purpose for which it is held. If the intention is to make a non-current investment it will be a non-current asset, but if it is a short-term way of investing spare cash it will be a current asset.

Question 18

What are short-term investments?

Are they a current or non-current asset?

Answer 18

Short-term investments are stocks and shares of other businesses, owned with the intention of selling them in the near future. The shares must be readily realisable (easy to sell) to be short term and therefore classed as a current asset.

Question 19

What are prepayments?

Are they a current or non-current asset?

Answer 19

Prepayments are amounts of money paid by the business in one reporting period for benefits which have not yet been enjoyed, but which will be enjoyed within the next reporting period.

For example, a business pays an annual insurance premium of £240, and the premium is payable annually in advance at 1 December. If the business has an accounting year end of 31 December, it will pay £240 at 1 December but only enjoy one month’s insurance cover by the year end. The remaining 11 months’ cover (£220 cost, at £20 per month) will be enjoyed over the next year. The prepayment of £220 is shown in the statement of financial position, at 31 December, as a current asset.

Question 20

What is a receivable?

Answer 20

A receivable can be due from any entity that owes the business money.

For example, if a business makes an insurance claim, the insurance company is a receivable for the money payable on the claim. If the business makes loans to staff to buy rail season tickets, staff are receivables for the amount outstanding.

Question 21

What is the distinction between trade receivables and other receivables?

Answer 21

Trade receivables represent customers who owe money for goods or services bought on credit in the course of the trading activities of the business.

Other receivables are due from anyone else owing money to the business, such as an insurance company, HMRC for VAT, or employees for season ticket loans.

Question 22

What are the component parts of the sole trader’s capital? (6)

Answer 22

The sole trader’s capital is usually analysed into its component parts:
1. Capital at the beginning of the period (i.e., capital brought forward)
2. Add additional capital introduced during the period
3. Add profit earned during the period (or less losses incurred in the period)
4. Less drawings
5. Retained profit for the period
6. Capital as at the end of the reporting period (i.e. capital carried forward)

Question 23

Define ‘Brought forward’.

Define ‘Carried forward’.

Answer 23

‘Brough forward’ means that the amount is brought forward from the previous period.

Similarly, ‘carried forward’ means carried forward to the next period.

The carried forward amount at the end of one period if therefore the brought forward amount of the next period.

Question 24

What is the distinction required by IAS 1 in the statement of financial position between non-current and current liabilities.

Answer 24

Current liabilities are debts which are payable within one year.

Non-current liabilities are debts which are payable after one year.

Question 25

Define a non-current liability.

Answer 25

A debt which is not payable within one year. Any liability which is not current must be non-current.

Question 26

Give two examples of non-current liabilities.

Answer 26

1. Loans which are not repayable for more than one year, such as a bank loan or a loan from an individual to a business.
2. Loan stock or debenture. These are common with limited companies. Loan stocks or debentures are securities issued by a company at a fixed rate of interest. They are repayable on agreed terms by a specified date in the future. Holders of loan stocks are therefore lenders of money to a company. Their interests, including security for the loan, are protected by the teams of a trust deed. If the loan is repayable over several years, then the portion repayable within one year is shown as a current liability.

Question 27

Define current liabilities.

Answer 27

Current liabilities are debts of the business that must be paid within one year, or within the entity’s normal operating cycle, that are held to be traded.

Question 28

Give examples of current liabilities. (6)

Answer 28

1. Loans repayable within one year, including the element of a long-term loan that is repayable within one year.
2. A bank overdraft, which is usually repayable on demand.
3. Trade payables represent suppliers to which the business owes money for goods or services bought on credit as part of the business’ trading activities.
4. Other payables due to anyone else to whom the business owes money, such as HM Revenue and Customs (HMRC) in respect of VAT, pensions trustees in respect of pension contributions, and employees in respect of unpaid remuneration, for example sales commissions.
5. Taxation payable to HMRC with respect to corporation tax on the company’s profits.
6. Accruals - These are expenses already incurred by the business, for which no invoice has yet been received, or for which the date of payment has not yet arrived.