L1 p2. A systematic approach to financial reporting: the accounting equation Flashcards
The accounting equation
A – L = OI
Ownership Interest Definition
The ownership interest is the residual claim after liabilities to third parties have been satisfied.
DEFINITION OF AN ASSET
An asset is a resource controlled by the entity as a result of past events.
•In other words:
•A present economic resource;
•controlled by the entity;
•as a result of past events.
An economic resource is a right that is capable of producing economic benefits
RECOGNITION-asset
Definition Criteria: Recognized as an asset if it meets the definition of an asset.
Relevance Criteria: The resulting information must be relevant and provide faithful representation.
Cost-Benefit Analysis: Costs of providing information should not exceed the benefits.
Relevance Uncertainty: Relevance is questionable if there’s uncertainty about the asset’s existence, future economic benefits, or measurability.
ASSETS OR NOT?
Land and buildings owned by a business.
•Raw materials owned by the business.
•Workforce employed by the business.
•Major advertising campaign undertaken by the business
Recognise ✅
land and buildings
raw materials
Relative certainty of future benefit
NOT recognise ❌
workforces
Advertising campaign
Uncertainty of benefits: lack of evidence that cash will flow to the business in the future.
Historical Cost vs. Fair Value
Historical Cost: The amount paid for an asset or agreed for a liability on the date the transaction first occurs.
Fair Value: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Current assets
Expected Realization: Anticipated to be realised or intended for sale or consumption within the entity’s normal operating cycle.
Held for Trading: Held primarily for the purpose of being traded.
Realization Timeframe: Expected to be realised within 12 months after the reporting period.
It is cash or a cash equivalent.
Non-current assets
Any asset that does not meet the definition of a current asset.
•Held for continuing use in the business.
•Also called ‘fixed assets’.
DEFINITION OF A LIABILITY
A liability is a present obligation of the entity to transfer an economic resource as a result of past events .
An obligation is a duty or responsibility that the entity has no practical ability to avoid
RECOGNITION OF LIABILITY
Meets the definition of a liability; and
•Resulting information is relevant* and provides a faithful representation; and
•Costs of providing information do not exceed benefits.
Relevance Uncertainty: Relevance is questionable if there’s uncertainty about the liability’s existence, future transfers of economic benefit, or measurability.
LIABILITIES NOT RECOGNISED
If an item fails the recognition test, it might be disclosed in the notes as a ‘contingent liability.’
Prudent Reporting: An illustration of the conservative nature of financial reporting practice.
Example: E.g., a potential liability for defective products, where the uncertainty exists about whether legal action will be taken.
Current liability
It is expected to be settled in the entity’s normal operating cycle or
•Held for the purpose of being traded or
•It is due to be settled within 12 months after the reporting period.
Non-current liability
Any liability that does not meet the definition of a current liability.
Also described as ‘long-term liabilities’.
CAUSES OF CHANGE IN OI
Normal Business Transactions: Supplying goods and services to customers.
Owner Contributions: Owner invests cash in the business.
Owner Withdrawals: Owner takes cash out of the business.
CAUSES OF CHANGE IN REVENUE AND EXPENSE
Revenue: increase in ownership interest (i.e. increase in assets are called revenue).
• Providing a service to a customer for which payment is made.
•Expense: decrease in ownership interest (i.e. decrease in assets are called expense).
Cost of providing a service to a customer.
