Chapter 2: How is a Statement of Financial Position Prepared and Analyzed?

Question 1

Trial Balance

Answer 1

A trial balance is a financial statement that lists the titles of T-accounts, their ending debit or credit balances, and totals the columns to check for equality between debits and credits.

Question 2

Current Ratio

Answer 2

The current ratio is a financial ratio used to assess a company’s short-term liquidity and its ability to pay current liabilities with current assets. It is calculated by dividing current assets by current liabilities.

Question 3

Trial Balance Spreadsheet

Answer 3

A trial balance spreadsheet is an internal document that lists T-accounts in financial statement order, displaying ending debit and credit balances for each account.

Question 4

Debit and Credit Balances

Answer 4

Debit balances are indicated in the left column, and credit balances are indicated in the right column of a trial balance, reflecting the nature of the accounts.

Question 5

Financial Statement Order

Answer 5

T-accounts in a trial balance are typically arranged in the financial statement order, which includes assets, liabilities, shareholders’ equity, revenues, and expenses.

Question 6

Equality Check

Answer 6

The trial balance is used to ensure that total debits equal total credits, serving as a check to identify errors in journal entries.

Question 7

Investing and Financing Activities

Answer 7

The statement of financial position can be prepared based on investing and financing activities, even before operating activities occur. It provides valuable information to external users.

Question 8

Shaded Accounts

Answer 8

In a trial balance, shaded accounts represent those whose balances changed due to investing and financing transactions, while non-shaded accounts retain their previous balances.

Question 9

External Users

Answer 9

External users, such as investors and decision makers outside the business, rely on financial statements, including the statement of financial position, to assess a company’s financial health.

Question 10

Example of a Trial balance

Answer 10

Question 11

Classified Statement of Financial Position

Answer 11

A classified statement of financial position is a formal financial statement that provides a snapshot of a company’s financial position at a specific date.

It classifies assets and liabilities into current and non-current categories for clarity and analysis.

Question 12

Comparative Data

Answer 12

Comparative data in a classified statement of financial position compares account balances at different dates, allowing for analysis of changes over time and assessing financial trends.

Question 13

Dollar Signs

Answer 13

Dollar signs are typically used at the top and bottom of both the asset and liabilities/shareholders’ equity sections to indicate the monetary units, often in thousands or millions.

Question 14

Financial Health Assessment

Answer 14

The classified statement of financial position is a critical tool for assessing a company’s financial health, as it provides a structured view of assets, liabilities, and equity, enabling stakeholders to gauge solvency and liquidity.

Question 15

Statement Heading

Answer 15

The heading of a classified statement of financial position typically includes the company’s name, the statement title (e.g., “Balance Sheet” or “Statement of Financial Position”), the date, and may indicate whether amounts are in thousands or millions.

Question 16

IFRS (International Financial Reporting Standards)

Answer 16

IFRS is a set of accounting standards used by many countries globally to improve the comparability and transparency of financial statements.

Question 17

Financial Statement Structure

Answer 17

The structure of financial statements can vary between countries, leading to differences in the order and presentation of account titles.

Question 18

Liquidity Order

Answer 18

Canadian companies often list assets in decreasing order of liquidity, while European companies tend to list assets in increasing order of liquidity.

Question 19

Equity vs. Liabilities Order

Answer 19

Some companies emphasize longer-term financing sources by listing equity before liabilities, and within liabilities, they may list non-current liabilities before current liabilities.

Question 20

Subheadings

Answer 20

Paying attention to subheadings in financial statements is crucial for understanding the classification of accounts.

Any account listed under the heading “liabilities” is a liability.

Question 21

Current and Non-Current Classification

Answer 21

Current and non-current classifications on the statement of financial position are essential for distinguishing assets and liabilities expected to be used or settled within the next 12 months (current) from those with longer-term horizons (non-current).

Question 22

Financial Ratio Analysis

Answer 22

Financial ratio analysis involves calculating and interpreting various ratios to assess a company’s past performance and financial condition. It serves as input for predicting future potential.

Question 23

Change in Ratios Over Time

Answer 23

Monitoring changes in ratios over time provides insights into how a company’s financial health and strategies have evolved.

Question 24

Comparison with Competitors

Answer 24

Comparing a company’s ratios with those of competitors or industry averages helps evaluate its relative performance and competitiveness.

Question 25

Current Ratio

Answer 25

The current ratio is a financial ratio that assesses a company’s short-term liquidity by comparing current assets to current liabilities.

Question 26

Net Profit Margin

Answer 26

Net profit margin is a financial ratio that measures a company’s profitability by expressing net profit as a percentage of revenue.

Question 27

Total Asset Turnover Ratio

Answer 27

The total asset turnover ratio evaluates how efficiently a company uses its assets to generate revenue.

Question 28

Return on Assets

Answer 28

Return on assets (ROA) is a financial ratio that indicates a company’s ability to generate profit from its assets.

Question 29

Industry Analysis

Answer 29

Understanding the industry and business environment is crucial for interpreting financial ratios effectively and making informed investment decisions.

Question 30

Predictive Role of Ratio Analysis

Answer 30

Ratio analysis serves as a tool for assessing a company’s financial health and performance, but the ultimate goal is to use this knowledge to make predictions about its future prospects.

Question 31

Confusing Bookkeeping with Accounting

Answer 31

Bookkeeping involves data entry for straightforward and repetitive transactions, while accounting requires a professional accountant with extensive knowledge and expertise in complex financial analysis, reporting, and more.

Question 32

Exactness of Accounting Numbers

Answer 32

Not all accounting numbers are precise; estimates play a role in financial statements, as demonstrated by examples like accounts receivable.

Question 33

Reporting Market Value in Financial Statements

Answer 33

Financial statements often report values based on historical cost, not market value, because historical cost can be verified with documents.

Question 34

Understanding Financial Statements

Answer 34

To interpret financial statements effectively, it’s crucial to understand their limitations and objectives. They provide valuable information but may not capture every detail

Question 35

Presentation of Assets and Liabilities

Answer 35

Publicly accountable enterprises have options for presenting assets and liabilities.

They can list assets in increasing order of liquidity and emphasize longer-term financing sources, or they can choose a different order if it provides more relevant information to financial statement users.

Question 36

Asset Valuation Methods

Answer 36

Publicly accountable enterprises can choose between the cost model and the revaluation model for reporting assets.

The revaluation model allows reporting assets at fair value, reflecting changes in their values over time.

Question 37

Presentation in IFRS

Answer 37

Under IFRS, non-current assets are typically presented before current assets, and equity is listed before liabilities.

Liabilities are presented in order of increasing time to maturity. However, flexibility exists to prioritize liquidity and maturity when relevant.

Question 38

Presentation in ASPE

Answer 38

Private enterprises, following ASPE (Accounting Standards for Private Enterprises), report assets in decreasing order of liquidity, with cash listed first.

Liabilities are reported in order of time to maturity, with current assets and liabilities appearing before non-current ones.

Question 39

Asset Valuation in ASPE

Answer 39

Private enterprises using ASPE are required to report assets at historical cost and are not permitted to record increases in these assets over time, unlike the revaluation option available in IFRS for publicly accountable enterprises.