Chapter 2: Assets, liabilities and the business entity concept Flashcards
What is an asset?
Give examples of assets. (8)
An asset is 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.’
- 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, license quotas (known as intangible assets
- Cash: in a bank account or held in notes and coins
- Inventory: goods held in 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 other to the entity
What is a non-current asset? Give an example.
Non-current assets are expected to generate economic benefits over a number of years.
An office building is occupied by administrative staff for years; similarly a machine has a useful life of many years before it wears out. Licences are normally granted for a certain period of time for example, a bus operating licence might give the right to operate buses in an area for a period of ten years.
What is a current asset? Give an example.
Current assets are expected to generate economic benefits in the short term.
A newsagent, for example, has to sell his newspapers on the same day that he gets them. The quicker a business sells goods, the more profit it is likely to make, provided, of course, that the goods are sold at a higher price than what it cost to the business to acquire them.
What is a liability?
Give examples of liabilities (3)
The Conceptual Framework states that ‘a liability is a present obligation of the entity to transfer an economic resource as a result of past events’.
- 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)
- 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 a current and non-current asset?
Liabilities for which economic resources 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.
Explain whether a business can own assets or have liabilities in its own name.
How does this differ for a limited liability company, limited liability partnership and sole trader?
Many businesses are carried on in the form of limited liability companies. The owners of a limited company are its shareholders, who may be few in number (as with a small, family-owned company) or very numerous (as with a large public company whose shares are listed on a stock exchange)
The law recognises a company as a legal entity, quite separate from its owners. A company may in it’s 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 become ‘insolvent’. However, the owners of the company are not usually required to pay the debt from their own private resources: the debt are not debts of the owners, but of the company.
The case is different when a business is carried on by an individual (a sole trader). There is no legal separation between a sole trader and the business he/she runs.
In most partnerships there is also 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, and therefore each partner (member) of the LLP has limited liability, however, it does not have shareholders and has other characteristics of a partnership.
What is the business entity concept?
In accounting any business is treated as a separate entity from its owner. This applies whether or not the business is recognised in law as a separate entity, i.e., it applies whether the business is carried on by a company or by a sole trader.
What is 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 deducing all its liabilities.’
