Measuring And Reporting Financial Positions Flashcards
What are the three financial statements and what are there aims?
The aim of them is to provide a picture of the financial position and performance of a business.
The statement of cash flow: This shows what cash movements took place over the period.
The income statement (p/l account): This shows the wealth generated by the business over the period.
The SOFP or BS: This shows the accumulated wealth at the end of the period and in what form it takes.
The SOFP
“Shows the accumulated wealth at the end of the period and what form it takes”
It sets out assets of a business on the one hand and the claims against the business on the other.
Criteria for assets
ASSETS
• Business resources (things of value to the business) and include cash and inventories
For an item to be an asset it needs to possess the following characteristics =
- A probable future economic benefit must exist: I.e. the item must be expected to have some monetary value, which can arise through the business’ hire or sale of the asset.
- The benefit must arise from 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
ALL 4 CONDITIONS MUST APPLY
Examples include:• Property • Plant and equipment • Trade receivables • Cash • Inventories (tangible asset) • Patents (intangible asset)
Assets can be split in to 2 types; tangible and intangible.
Claims
“An obligation of the business to provide cash or some other form of benefit to an outside part”
Two types:
Equity: This represents the claim of the owner(s) against the business.
Liabilities: This represents the claims of others.
Business Entity Convention
For accounting purposes, the business and its owner are treated as being quite separate and distinct. This is why owners are treated as being claimants against their own business.
The business entity convention must be distinguished from the legal position that may exist between businesses and their owners. E.g. For sole traders and partnerships, the law does not make any distinction between the business and its owners.
Historic Cost Convention
This holds that the value of assets shown on the SOFP should be based on their acquisition cost (historic cost).
Arguably recording assets at their current value would provide a more beneficial and realistic valuation. However there are problems associated with doing this. ‘Current values can take a number of definitions’, either the current replacement cost of current realisable value of the asset. These can produce quite contrasting figures and both can have different definition themselves, current values may depend heavily on the opinions of managers. .
Prudence Convention
This holds that caution should be exercised when making accounting judgements. the application of this normally involves recording all losses and expected losses at once and in full rather than when the goods are eventually sold.
However profits are only recognised when they actually arise. Therefore is paid more on expected profits and expected losses. It is designed to protect against overstatement of the financial position and performance but it is done on judgement and carried out by prepares of the financial statements who may differ in how much prudence they applied.
An example of the prudence convention:
Some inventories held by the business prove unpopular with customers and so a decision is made to sell them below their original cost to get rid of them. The prudence convention would require that the expected losses from future sales be recognised immediately rather than when the goods are eventually sold. However if these inventories could have been sold above their original cost, profit would only be recognised at the time of sale.
Going Concern Convention
This holds that the financial statements should be prepared on the assumption that a business will continue operations for the foreseeable future, unless there is evidence to the contrary. I.e. it is assumed that there is no intention, or need, to sell-off the non-current assets of the business.
Some businesses may have to sell off their non current assets in order to avoid liquidity. The realisable value of the NCA will be much lower than what is recorded and therefore big losses will be had.
Dual Aspect Convention
Each transaction has two aspects both of which will affect the SOFP.
Money Measurement
A resource will only be regarded as an asset and included on the SOFP if it can be measured in monetary terms with a reasonable degree of reliability.
There are examples of key resources of a business that normally defy reliable measurement: Goodwill and Brands.
These are examples of products that often lack a clear and separate identity. The term goodwill if often used to cover various attributes such as the quality of the product, the skill of the employees and other attributes. The term ‘product brand’ is also used to cover attributes such as brand image, trademark etc.
Arms-Length Transactions
This is a transaction undertaken between two unconnected parties. if goodwill is acquired when taking over another business, or if a business acquires a particular product vend from another business, these items will be separately identified and a price agreed for them. Under these cirmcuastances they can be regarded as assets.
Arms length transactions are usually required before such assets can be reliably measured and reported on the SOFP.
Asset Valuation
The ‘benchmark treatment’ is used to show non-current assets at historic cost. Fair values maY be used rather than historic coast provided that they can be reliably obtained. This is rarely possible, however, for intangible non-current assets.
Non-current assets with a finite lives should be shown at cost (or fair value) less any accumulated depreciation (amortisation).
Where the value of NCA is impaired it should be written down to its recoverable amount.
Inventories are shown at the lower cost or net realisable value.
