L3 - Statements of Financial Position

Question 1

What are the Three Primary Financial Statements?

Answer 1

• Statement of Financial Position (balance sheet) - showing the value of the organisation at a single moment
• the Income Statement (Profit and loss Account) - (P&L) explaining the increase or decrease in value occurring in the period from the previous Balance sheet
• Cash Flow Statement - (CFS) showing what cash has been received or spent during the accounting period

Question 2

What do the Primary Financial Statement show?

Answer 2

• the position statement shows a single moment in time

The Income Statement and cash flow Statements tell the ‘story’ (performance) between successive position statements

Question 3

What is the Basic Accounting Equation for the Position Statement?

Answer 3

• Total Assets = Total Claims (on the entity)

Question 4

What is an Asset?

Answer 4

• Is essentially a resource held by a business
• For a particular item to be treated as an asset, for accounting purposes, it should have the following characteristics:
• A probable future economic benefit must exist
• The benefit must arise form some past transaction or event
• The business must have the right to control the resource
• The asset must be capable of measurement in monetary terms

Question 5

What does it mean by an Asset must have a probable future economic benefit?

Answer 5

• An economic benefit is one that will have some monetary value
• This value may arise either through the item’s future use within the business or through its future hire or sale
• Thus an obsolete piece of equipment that can be sold for scrap would would be considered an asset, whereas something that has no scarp value would not be regarded as one

Question 6

What does it mean by an Asset having a benefit that must haven risen from some past transaction or event?

Answer 6

• In other words, the transaction (or other event), giving rise to a business’s right to the benefit, must have already occurred and will not arise at some future date
• E.g. an agreement by a business to buy a piece of equipment at some future date would not mean the item is currently an asset of the business

Question 7

What does it mean by a business must have the right to control the Asset?

Answer 7

Unless the business control the resource, it cannot be regarded as an asset for accounting

• To a business offering holidays on barges for example, the canal system may be a valuable resource but, as the business will not be able to control the access of other to the canal system, it cannot be regarded as an asset of the business
• However any barges o=owned by the business would be regard as assets

Question 8

What does it mean that an Asset must be capable of being measured in monetary terms?

Answer 8

• Unless the item can be measured in monetary terms, with a reasonable degree of reliability, it will not be regarded as an asset for inclusion on the statement of financial position
• e.g. for instance the title of a magazine that was created by its publisher may be extremely valuable to that publishing business, but this value is difficult to quantify
• it will not therefore be treated a an asset

Question 9

What sort of item often appear as Assets in the Statement of Financial Position of a Business?

Answer 9

• property
• plant and equipment
• fixtures and fittings
• patents and trademarks
• trade receivable (debtors)
• investments outside the business

Question 10

What are the different types of Assets of a Financial Position Statement?

Answer 10

• Current Assets
• Non-Current Assets
• Plus and surplus cash at bank

Question 11

What are Current Assets?

Answer 11

• They are short term, technically under 1 year
• held for sale or consumption during the business’s normal operating cycle ( the time it normally takes from creating the product to receiving that cash from its sale
• they are expected to be sold within a year after the date of the relevant statement of financial position
• they are held principally for trading
  they are cash, or near cash such as easily marketable, short term investment

Question 12

What are the most common Current Assets?

Answer 12

• Inventory (stocks)
• Receivables ( money owed by customers for sales on credit)
• cash

Question 13

What are Non-current Assets?

Answer 13

• held for longer terms usually more than 1 year
• Tangible –> items such as land, building, plants and equipment, motor vehicle
• Non- tangible –> financial investments, patents, brand name

Question 14

When is Goodwill shown on an Position Statement?

Answer 14

• Goodwill is not shown unless purchased

- it value can also be lost

Question 15

Is a gift included in the Statement of Financial Position?

Answer 15

• something given to you is not an asset in accounting terms

Question 16

What are Claims?

Answer 16

• a claim is an obligation of the business to provide cash, or some other benefit to an outside party
• these normally arise as a result of the outside party providing assets for use of a business

Question 17

What are the different types of Claims?

Answer 17

• Capital (also know as equity) –> contributed by and owed to the owners/shareholders
• Loans from banks, friends etc.
• Other liabilities –> Everything else owed by the business
• If the business have negative cash ( owes the bank and has access to an overdraft system) we put that money here

Question 18

What is equity?

Answer 18

• This represents the claim of the owner(s) against the business
• Sometimes referred to as the owner’s capital
• Any funds contributed by the owner (even a sole trader) will be seen as coming from outside the business and will appear as a claim against the business in the SOFP

Question 19

What are Liabilities?

Answer 19

• represent the claims of all individuals and organisations apart from the owner(s). They arise from past transaction or events such as supplying goods or services or lending money to other business
• A liability will be settled through an outflow of assets (usually cash)

Question 20

What is the extended Accounting equation?

Answer 20

Assets (at end of the period) = Equity (amount at the start)+ Profit/Loss (for the period) + Liabilities (at the end of the period)

Question 21

What are Current Liabilities?

Answer 21

• Usually less than 1 year. normal operating cycle
• Held principally for trading purposes
• There is no right to defer settlement beyond a year after the date of the relevant SOFP

Question 22

What are Non-Current Liabilities?

Answer 22

• Usually over 1 year

- They can switch from Non-Current to Current Liabilities the closer they are to their due date

Question 23

What is the standard lay out of a Statement of Financial Position?

Answer 23

• Non-current Assets
• Current Assets
• Total Assets
• Non-current Liabilities
• Current Liabilities
• Equity
• Equity + liabilities

Question 24

What are some general convention when setting out a Statement of Financial Position?

Answer 24

• Under the asset section items are listed in reverse order of liquidity (nearness to cash)
• so those assets further from cash come first and those closest come last
• Always established the date it was drawn up as it is capture a moment in time and the time before/after that could be very different

Question 25

How is Going Concern defined in Accounting Terms?

Answer 25

• The going concern convention holds that the financial statement should be prepared on the assumption that the a business will continue operation for the foreseeable future, unless there is evidence to the contrary
• In other words, it is assumed that there is no intention or need, to sell of the non-current assets of the business

Question 26

What are some resources of a business that cannot usually be measured reliably in monetary terms?

Answer 26

• the quality of the human resources of the business
• the reputation of the business’s products
• the beneficial location of the business
• the relationship the business enjoys with its customers

Question 27

Why is Goodwill and Product bran excluded from the Statement of Financial Position?

Answer 27

• While some intangible non-current assets that have clear and separate identity adn the cost of acquiring the asset can be reliable measure e.g. patents, trademarks, copyright etc.
• Goodwill however lacks a clear and separate identity as it covers various attribute such as the quality of the product, skill of employees
• Product brand cover attributes like the brand image, quality of the product, the trademark on it
• as they both have been generate internally in the business it is difficult to determine their cost or to measure their current market value, they are, therefore excluded

Question 28

What are Arm’s-length transaction?

Answer 28

• a transaction is one that is undertaken between two unconnected parties

Question 29

What are Reserves?

Answer 29

• Represent the profit retained ( the profit that has been earned since the business was set up, but which has not yet been paid out as dividends
• Reserves are not cash (necessarily) but rather will have been invested in either non-current or current assets (working capital) to help the business grow further

Question 30

What does Capital include?

Answer 30

• the money originally put into a firm (the issued ordinary shares) plus reserves (retained profits) and represent the total amount owed to ordinary shareholders

Question 31

Whats the different between Non-current Assets with finite lives and those with indefinite lives?

Answer 31

• Benefits from assets with finite lives will be used up over time as a result of market changes, wear and tear and so on
• The amount used up, which is referred to as depreciation ( or amortisation) in the case of intangible non-current assets)
• Whereas those with indefinite lives may or may not be used up over time therefore these assets are not subject to routine annual depreciation in each reporting period

Question 32

What is the Net Book Value?

Answer 32

• Also referred to as carrying amount or written down value

- it is the cost of the asset - the total depreciation to date

Question 33

What is Fair Values in Accounting?

Answer 33

• While historic cost is the standard there is a alternative allowed called fair values
• Non-current assets may be record using fair valued which is the current market values (that is, the exchange values in an arm’s length transaction)
• This is allowed if these values can be measured reliably
• This can provide the user with more up-to-date information which may well be more relevant to their needs
• this could also change how the SOFP looks as indefinite assets may have appreciated in value so are more valuable but finite non-current assets will have an increased depreciation charge because it is based on the new (increased) value of the asset
• Intangible assets aren’t revalued to fair values as there is no active market for most intangible assets

Question 34

What is Impairment Loss in Accounting?

Answer 34

• Non current assets are at risk of suffering a significant fall in value, this could be due to market condition, technological obsolescence etc.
• In some cases this may lead to the carrying amount of the asset being higher than the amount that could be recovered from the asset through its continued use or through its sale
• When this happen the asset value is said to be impaired and the general rule is to reduce the value of the SOFP to the recoverable amount
• The amount by which the asset value is reduced is known as an impairment loss

Question 35

How is Impairment loss different to Depreciation?

Answer 35

• Routine Depreciation is concerned with the normal wear and tear of usage and/or the passage of time
• An impairment loss is a reduction in the value of the asset through some fundamental change, sometimes a rapid one, in the commercial or technological environments

Question 36

When do you use Net Realisable Value on Inventories?

Answer 36

• Inventories can run the risk of a significant fall in value due to changes in market taste, obsolescence, deterioration, damage etc.
• When a fall in the value means that the amount likely to be recovered from the sale of the inventories will be lower than their cost this loss must be reflected in the statement of financial position
• Thus if the net realisable value ( selling price - selling cost) falls below the historic cost of inventories held we would Net Realisable Value as the basis of valuation

Question 37

What are the Uses of the Statement of Financial Position?

Answer 37

• Provides insights about how the business is financed and how its fund are deployed
• It can provide a basis for assessing the value of the business
• Relationships between assets and claims can be assessed - gearing of the company , can its short-term assets cover its maturing obligations ( debts)
• Performance can be assessed - effectiveness of generating wealth assessed against the amount invested thus see a relationship between profits earned during a period and the value of the net assets invested –> can help many users particularly owners and managers

Question 38

How is Provides insights about how the business is financed and how its fund are deployed a Use of the Statement of Financial Position?

Answer 38

• How must is contributed by owners vs, outside lenders

- What kinds of assets have been acquired and how much is invested in each kind