statement of financial position

Question 1

what is the statement of financial position and what is it a report of?

Answer 1

It is a report that summarises a company’s assets (economic resources that it owns and is owed), its liabilities (what it owes in financial terms and other obligations) and its equity (claims of its owners)

Question 2

what is the SOFP also a statement of?

Answer 2

statement of a business entity’s (e.g. company, partnership, individual trader) financial condition at a moment in time (referred to as a snapshot albeit a blurred one)

Question 3

how often do public companies publish their statements of financial position?

Answer 3

at the end of a financial year, half-year or quarter

Question 4

what do the two equal and opposite sides show?

Answer 4

where a firm’s funding has come from and how these funds have been deployed

Question 5

what is the IFRS definition of an asset?

Answer 5

“An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits”

Question 6

what are the asset recognition requirements?

Answer 6

controlled by the firm - they are an economic resource controlled by the firm, which in many cases involves ownership of the asset
measurable and have a measurable value or cost. Items that do not have a quantified value cannot be included in the financial statements

Question 7

what are examples of assets where items are owned by the company?

Answer 7

• cash and cash equivalents
  -tangible assets
  -intangible assets

Question 8

what are examples of assets where amounts are owed to the company?

Answer 8

-from sale of goods and services on credit to customers
-from any loans made

Question 9

what are examples of assets where services and goods are owed to company?

Answer 9

• from services and goods that the firm has paid for in advance

Question 10

what is excluded from the SOFP?

Answer 10

SOFP excludes assets that are economic resources of the firm but whose cost or value cannot be measured with reliability or fail the control requirement.

Question 11

what kind of assets are excluded from the SOFP?

Answer 11

human resources:
-people are often a firm’s “most valuable asset” but we don’t put a monetary value on their heads
-companies do not ow or control people

intangible assets:
-IFRS requires firms to expense R&D costs and marketing expenditure. Intellectual property created by the firm itself through their own research or through their marketing activities does not appear in the SOFP.
- most can only be recognised if purchased
- book value of technology and pharmaceutical firms understated

Question 12

how are assets classified?

Answer 12

on basis of intent into current and non-current assets

Question 13

what are current assets and how are they classified?

Answer 13

assets that the firm intends to trade/sell or consume/use up in the next 12 months. Current assets also include cash and financial assets that the firm is due to receive within 12 months of the date of the SOFP.

Question 14

what are non- current assets and how are they classified

Answer 14

assets that the firm does not intend to sell, us or dispose of in the next 12 months. They intend to keep these assets for 12 or more months.

Question 15

what are the cash and other financial assets under current assets?

Answer 15

cash and other financial assets: cash and cash equivalents and other financial assets where the firm expects payment within 12 months

Question 16

what is inventory defined as under current assets?

Answer 16

raw materials, work-in progress and finished goods are recorded in their inventory accounts. Inventory is also known as “stock”

Question 17

what are trade receivables defined as under current assets?

Answer 17

amounts owed to the firm by its customers that are due for payment within 12 months. These arise as a result of credit sales made by the firm where the customer pays for goods they have bought in arrears

Question 18

what are prepaid expenses and prepayments defined as under current assets?

Answer 18

assets created when a firm pays its suppliers for services or goods in advance and that are due to be delivered within 12 months e.g. rent or travel tickets. The value shown refers to the value of services or goods owed to the company by its suppliers.

Question 19

what is PP&E defined as under non-current assets?

Answer 19

Property, plant and equipment are sometimes referred to as tangible or fixed assets employed in the operations of the firm. PP&E may include land, buildings, equipment, trucks and automobiles. PP&E usually forms the largest part of non-current assets

Question 20

what are intangible assets defined as under non-current assets?

Answer 20

items which bring economic benefit to the firm but have no tangible form. They may comprise intellectual property rights such as patents, brand, trademarks and royalties. They may also include licenses and mineral extraction rights. Computer software is considered an intangible asset as are player registrations.

Question 21

what is goodwill defined as under non-current assets?

Answer 21

goodwill is an artefact - an accounting sleight of hand - that arises from the accounting treatment of a firm’s past acquisitions of other companies. It is reported within non-current assets but is not as asset as such.

Question 22

what does the IFRS define as a liability?

Answer 22

A liability is a present obligation of the entity to transfer an economic resource as a result of past events

Question 23

what are examples of liabilities?

Answer 23

liabilities are financial in nature, but other obligations may include goods and services that have been paid for by, and are owed to, a firm’s customers.

amounts owed to financial creditors: e.g. loans from banks and bonds issued by the firm

amounts owed to trade and other creditors: amounts owed to suppliers for goods and services bought on credit and to other creditors including tax authorities

goods and services owed: a firm may also owe its customers goods and services that have been paid for in advance

Question 24

how are liabilities classified?

Answer 24

into current and non-current liabilities based on when the obligations are due to be discharged (their due date)

Question 25

what are current liabilities?

Answer 25

short-term in nature and represent obligations that are due to be paid or discharged within the next 12 months of the date of the SOFP.

Question 26

what are non-current liabilities?

Answer 26

amounts that are due to be paid for 12 or more months after the date of record of the SOFP.

Question 27

what are trade payables and accrued expenses defined as under current liabilities?

Answer 27

amounts the firm owes to it suppliers and service providers for goods it has purchased and services it has used paid in arrears (for goods it has purchased and services it has received but not yet paid for). They represent the amounts owed to suppliers for goods the firm has bought on credit

Question 28

what is unearned income defined as under current liabilities?

Answer 28

a liability created when a supplier accepts payment in advance from customers for goods and services the supplier has committed to deliver at a future time within the next 12 months e.g. flights/holidays/sports tickets

Question 29

what is short-term borrowing defined as under current liabilities?

Answer 29

financial obligations due for payment within 12 months including overdrafts from banks and money market instruments, such as commercial paper, that the firm has issued

Question 30

what is tax payable defined as under current liabilities?

Answer 30

this represents tax that is owed and that is due to be paid within the next 12 months

Question 31

what are loans defined as under non-current liabilities?

Answer 31

commercial banks are an important source of medium and long-term financing for firms. These loans may be from individual banks or larger amounts may be from syndicates of banks to spread credit risk. Loans from banks may be fixed rate or floating rate, they may be term repayment loans or bullet loans (where all of the principal is repaid at the end of the loan’s term)

Question 32

what are bonds issued by the firm defined as under non-current liabilities?

Answer 32

banks issued by the firm and bought by institutional investors such as pension and mutual funds are a more important source of such funding. Most bonds have fixed interest rates and, for those issued by companies, a term of 3-5 years. Interest is normally paid either annually or semi-annually and the principal repaid at the end of the bond’s term.

Question 33

what are deferred tax liabilities under non-current liabilities?

Answer 33

taxes that the firm owes but are not due for payments in the next 12 months

Question 34

what is the entity concept

Answer 34

a business is a separate legal person from its owners and they are treated as two separate parties.
Business transactions for the firm, its assets and its liabilities are separate from those of its owners
the financial statements represent the affairs of the firm and not of its owners

Question 35

what are the rights and responsibilities of business entities?

Answer 35

business and owners are separate entities and the assets and liabilities that are all its own and can undertake business transactions with its owners as third parties. These include:
ownership of assets: they can own title to assets
contracts: they can enter into legally binding contracts with third parties. A named individual within the firm may actually authorise and sign for such agreements but they act in their capacity as a named representative of the company rather than on their own account.
financial liabilities: each entity can have liabilities and other obligations of its own that it is responsible for, they may have guarantors for their own liabilities and they may act as a guarantor for the liabilities of other entities
tax: each business entity is taxed separately
criminal and civil liabilities: they can be held liable for criminal and civil offences committed by their employees when working for the firm and have to pay fines and damages for those actions. A company can be prosecuted for failing to follow laws on employee working conditions and held liable for deaths caused by actions of its employees acting on the company’s behalf

Question 36

what are examples of business transactions where the entity concept must be taken into account?

Answer 36

expenses: the owner refurbishes their personal property. They are not allowed to treat these refurbishment costs as expenses incurred by the firm. This would have the effect of reducing the firm’s reported profit and tax liability

disposal proceeds: a firm disposes of an asset it owns. The proceeds from disposal must go to the firm not the owner. This is essential to protect creditors of the firm from unscrupulous owners attempting to defraud them.

use of property owned by the owner: the owner of the firm also owns office space which is rented out to the company. Rent becomes an expense at the company and income for the owner. Owner may be taxed on this income

owner withdrawals: the owner takes money from the firm. This must be recorded as either a loan from the firm to the owner or as a reduction in owner’s equity. In most countries any such withdrawals have to be reported to tax authorities and may be subject to legal restrictions intended to protect creditors.

Question 37

what is the IFRS definition of equity?

Answer 37

equity is the residual interest in the assets of the equity after deducting all its liabilities

Question 38

what is equity?

Answer 38

• equity represents the value of the the owners’ interests
  -investments made by owners (share capital) into the firm plus retained earnings
  -its value is given by the difference between what the net company owns (its assets) and what it owes (its liabilities) - equal to the “net assets” of the firm
• shows how much the value of the owners’ interests are “worth” in accounting terms - sometimes referred to as “book value” of firm

Question 39

what does equity have no direct relationship with?

Answer 39

• the market value of the firm if listed
• the amount that would be left over if the firm was liquidated, all the assets were sold off and all creditors were paid off

Question 40

what is share capital and share premium under equity?

Answer 40

accounts used to record the amount of new capital that the owners have invested into the firm since it was established

Question 41

what are retained earnings under equity?

Answer 41

the cumulative value of earnings (profit after tax) generated by the company since it was formed less dividends paid out to the owners

Question 42

what are other reserved under equity?

Answer 42

a number of other reserves reflecting changes in the values of certain assets and liabilities which, for various technical reasons, have not been taken through SOPL.

Question 43

what is the accounting equation for?

Answer 43

the accounting equation and its application are responsible for ensuring that the two sides of the SOFP must always be equal and explains why this financial report is commonly referred to as the balance sheet

Question 44

what is the accounting equation?

Answer 44

Assets = liabilities + equity

OR

equity = assets - liabilities

Question 45

Explain the “balance sheet”

Answer 45

• all transactions that are entered into the firm’s financial records must comply with this equation. This ensures that both sides of the statement of financial position must always balance.
• A transaction must always have at least two entries into the financial records for the accounting equation to be satisfied. It is this dual treatment of all transactions that lends itself to the name of ‘double-entry book-keeping’

Question 46

what is another way of looking at equity? (another equation)

Answer 46

equity is also equal to the value of initial investment made by the owners plus retained earnings and means we can view equity as having two perspectives.

share capital + retained earnings = equity = assets - liabilities

Question 47

what is the framework for determining asset and liability values?

Answer 47

going concern basis

Question 48

what is the going concern basis

Answer 48

financial statements are prepared on the basis that the entity concerned is a “going concern”

Question 49

what is the going concern concept?

Answer 49

when the board of directors state that a reporting entity (e.g. company) is a going concern they are asserting that the company will continue to trade normally for the foreseeable future and that they know of no reason why the company would either choose, or be forced, to stop trading. If the board knew that the company was going to stop trading or enter liquidation the financial statements would have to be prepared under a different basis.

Question 50

what is the going concern principle?

Answer 50

“financial statements are normally prepared on the assumption the reporting entity is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the entity has neither the intention nor the need to enter liquidation or to cease trading.
If such an intention or need exists, the financial statements may have to be prepared on a different basis. If so, the financial statements describe the basis used”

Question 51

explain the historic cost convention

Answer 51

the going concern principle justifies the use of historical cost for most assets
- historic cost: most assets are recorded at the costs that have been expended on them
- fair value/ market value: in certain cases at fair value or market value
rather than at their liquidation value or replacement cost.

Question 52

what is the IFRS definition of historic cost?

Answer 52

“The historic cost of an asset when it is acquired or created is the value of the costs incurred in coacquiring or creating the asset, comprising the consideration paid to acquire or create the asset plus transaction costs”

Question 53

what is liquidation value?

Answer 53

the value that could be obtained if a firm is put into liquidation (wound up) and as asset had to be sold rapidly
the value of assets of a firm placed in administration with a view to winding up the business is always much lower than if the firm is expected to continue to run as a going concern

Question 54

what is replacement cost?

Answer 54

how much it would cost to replace an asset of equal value at the present time. This value is often specified in insurance contracts.

Question 55

what is market value?

Answer 55

market values for individual assets are usually based on quoted prices. In practice market values are only applied to certain traded financial assets such as the shared in companies listed on a stock exchange where a market price is readily available.

Question 56

what is fair value?

Answer 56

the price that would be received to sell an asset in an orderly transaction between market participants at that time. Fair values for individual assets are usually based on appraised (estimated values)

Question 57

how are the values of liabilities determined?

Answer 57

liabilities represent obligations to other firms etc. These are either accounted for at historical cost or fair value:
historical cost: the agreed value of the liability at inception plus any unpaid interest incurred. This is also known as amortised cost
Fair value: the amount the firm would have to pay to transfer an obligation to a willing third party in an orderly manner or settle it

Question 58

what do the notes to accounts show in terms of accounting policies, standards and estimates?

Answer 58

some notes are used to explain what accounting policies the firm has applied in drawing up the financial statements. Where appropriate, the firm may also disclose values for any accounting estimates that is has made.

Question 59

what do the notes to the accounts show in terms of qualitative disclosures?

Answer 59

this may include some explanation for what an item comprises, for example the types of properties held or the major sources of ‘other income’. They may also explain some of the reasons behind changes from one year to the next.

Question 60

what do the notes to accounts show in terms of greater granularity (breakdown)?

Answer 60

many of the line items reported in the summary SOFP are comprised of multiple accounts and the notes may provide a further breakdown of these giving greater granularity. e.g. a firm may give a single value for associates in the SOFP but list them all in the notes and give the value of each investment.

Question 61

how do UK and US firms differ in the presentation of their assets?

Answer 61

UK companies mostly report NC assets first and then C assets. In the US and many other countries, however, the convention is to show current assets first followed by non-current assets (in order of liquidity and is more congruous with the order that liabilities are presented).