Lecture 3: The Balance Sheet - Assets Flashcards
What is the balance sheet and what does it show?
The balance sheet is a visual representation of the accounting equation (A = L + Eq).
It shows us the financial position at a specific point in time and tells us about the investment (aquiring of assets) and financing (the debt/equity mix of liabilities and equity) decision. Allows users to assess liquidity, solvency and capital structures.
What does the total assets figure represent?
The current minimum future economic benefits estimated by management - NOT the value of the business.
What is a consolidated balance sheet?
A balance sheet showing the financial position of te business and all its subsidaries (company controlled by a holding company)
Limitations of the balance sheet
- It shows stocks at a single point in time rather than flows risking the fact that the stocks may be atypical on the date they are reported
- Real value of business may not be reflected as not all assets/liabilities/equity are included, there is a range of measurements used (ie. cost and fair value) and the flexibility alloted to businesses means that they can pick whichever value paints the business in best light.
What is clarifying assets and why is it done?
Clarifying assets included current/non-current classifications, as well as grouping them according to classes of similar nature and use.
This is done because it improves understandability.
Major classes of current assets
Cash and cash equivalents - assets that are very liquid and are subject to little change in value (if cash equivalents are longer-term and subject to changes in value it is an investment).
Trade and other receivables:
- Trade receivables - amount owed by customers from their purchase of the entity’s goods and services on credit
- Other receivables - amounts owed by others e.g. employees for loans or rebates from suppliers.
Inventories - finished goods, work in progress or raw materials held for sale in the ordinary course of business.
Other current assets - prepaid expenses (paid the cash but haven’t used up the benefits) and accrued revenue (earned but haven’t received the cash)
Allowance for doubtful debts
Contra asset that offsets total receivables to ensure that the carrying value is not higher than the carrying value
Major classes of non-current assets
PPE - tangible items held for the use or supply of goods/services, for rental to others or for admin purposes.
Intangible assets - assets without physical substance that must have been acquired and have an identifiable cost - can be amortised, carried at cost or fair value and impaired.
- Goodwill - a special intangible asset that is only recognised when acquired from another business - can only be carried at cost and can be impaired.
Other financial assets - shares in other companies, bonds, derivatives, hedging instruments.
Depreciation - the allocation of the depreciable value of an asset over its useful life - represents the consumption of an assets economic value,
Measurement of PPE
At time it is acquired:
- Carried as a cost which, includes the cash paid, plus the capitalised costs (e.g. getting it to to where it is)
After it is acquired:
- Either carried at cost or fair value
- Trade off as cost is a better faithful representation whereas, fair value is a more relevnt value
Impairment of PPE
PPE must be reported at the lower of carrying value or recoverable amount to ensure it is not overstated:
- Carrying value is either cost or fair value (depending on judgement)
- Recoverable amount is the amount expected to be generated from the assets use or sale
Risk in preparing balance sheet
Overstating the recverable amount of assets
Agency issues apparent in assets
Arise whenever choices, estimations and judgements are available which may lead to the manipulation of reports to paint a certain picture.
- Receivables - allowance for doubtful debts can be estimated
- Inventory - different cost assignment methods can be used to allocate the lowest cost price
- PPE - choosing carrying value, measurement, impairment etc.
- Intangibles - impairement, choosing carrying value.
