Week 2 - Statement of Financial Position Flashcards
What does the statement of financial position show?
- The resources the business controls: ASSETS
- How the assets were financed
From Owners: EQUITY
From Lenders: LIABILITIES
The statement of financial position also shows the financial strengths and weaknesses of a company
State the balance sheet equation
Assets = Equity + Liabilities
Non-current Assets + Current Assets = Equity + Non-current Liabilities + Current Liabilities
What is an asset?
- Resources controlled by business
- Capable of providing future economic benefits
- Obtained from a past event
What is the difference between a current and non-current asset?
•Short term benefits = Current Assets - Benefits occur within one year - Current assets are cash, or cash equivalents, or things that are expected to become cash within a year •Long term benefits = Non-Current Assets - Benefits occur over several years
State some examples of current assets?
Inventories (or stocks) Trade receivables (or debtors) Investments Prepayments Cash
What are inventories (or stocks)?
Merchandise, production supplies, materials etc.
What are trade receivables (or debtors)?
Money owed by customers for goods or services supplied on credit
What are investments?
Short term financial investments
What are prepayments?
Expenses/items paid for in advance of receiving their benefits
Give an example of a prepayment
• I open a business and pay two years’ rental charges
– that is £80,000 ( 2 x £40,000)
• However, only one year’s rental charge will appear
on my income statement (expense incurred in
generating that year’s sales)
• So my profit (liability) is down by £40,000 but my
cash (asset) is down by £80,000
• To balance this out, I have a prepayment (next
year’s rental charge) of £40,000 in my current assets
What are the three types/stages of inventories (or stocks)?
Raw materials
Work in progress
Finished goods
What is the future economic benefit of a current asset in the form of raw materials?
Used to manufacture goods for sale
What is the future economic benefit of a current asset in the form of goods that are a work in progress?
Expectation of completion and sale
What is the future economic benefit of a current asset in the form of finished goods?
Expectation of sale
What is the future economic benefit of a current asset in the form of trade receivables?
Expectation that the customer will pay cash
What is the future economic benefit of a current asset in the form of investments in shares of other companies?
Expectation of dividend income and growth in value of investment, for future sale
What is the future economic benefit of a current asset in the form of cash held in a bank account?
Expectation of using the cash to buy resources which will create further cash
Comment on the circulating nature of current assets
Cash —> Inventories (stock) —> Trade receivables
(trade debtors)
Full cycle on page 20 of Week 2
State some examples of non-current assets?
Tangible fixed assets
Intangible assets
Financial assets or investments
Name some tangible fixed assets
Land and buildings
Plant and equipment
Vehicles
What are tangible fixed assets?
Property, plant and equipment; motor vehicles; furniture
What are intangible assets?
Goodwill; patents; trademarks; licences
What are financial assets or investments?
Shares in other companies or loans that have been made
What is the future economic benefit of a non-current asset in the form of land and buildings?
Used in continuing operations of the business; potential for sale of the item
What is the future economic benefit of a non-current asset in the form of plant and equipment?
Used in continuing operations of the business
What is the future economic benefit of a non-current asset in the form of vehicles?
Used in continuing operations of the business
What is a liability?
A liability is something which must be paid in the future.
What is a current liability?
Payable in the short term within a year
Give some examples of current liabilities
- Trade payables
- Accruals
- Corporation tax payable
- Bank overdrafts
What is an accrual?
An accrual is an item that should have been paid for, but hasn’t
Give an example of an accrual
For example, when the accounts were drawn up the final quarter’s electricity bill had not arrived
Accrual
For example, when the accounts were drawn up the final quarter’s electricity bill had not arrived.
Explain why this is an accrual
This was an expense incurred in generating
that year’s sales, it must be shown in the accounts
What is a non-current liability?
Payable after more than one year
Give some examples of non-current liabilities
Long-term borrowings: loans, mortgages, bonds
What is the obligation associated with a liability in the form of bank loans and overdrafts?
The entity must repay the loans on the due date
or on demand
What is the obligation associated with a liability in the form of trade payables?
Suppliers must be paid for the goods and services
supplied, usually about one month after the
supplier’s invoice is received
What is the obligation associated with a liability in the form of taxation payable?
Cash payable to HMRC. Penalties are charged if
tax is not paid on the due date
What is the obligation associated with a liability in the form of an accrual (a term meaning
‘other amounts owing’, such as unpaid bills)?
Any expense incurred must be reported as
an accrued liability (e.g. electricity used, gas used, unpaid wages), if it has not been paid at the financial year-end date
What is the obligation associated with a liability in the form of Long-term loans (or debenture loans)?
Statement of financial position will show
repayment dates of long-term loans and any repayment conditions attached
What is equity?
The owner’s interest in the business
State some examples of equity
Shareholders’ Capital
Share premium
Retained profits
Other reserves
What is shareholders capital?
Book (or par) value of shares
What is share premium?
Excess paid over the book (or par) value of shares
What are retained profits
Profits after tax made by the business not yet distributed to the owners
What are other reserves?
Revaluation reserve
How do we calculate change in equity?
Change in equity during the year = Profit for the year minus any dividends
plus any additional shares that have been issued
plus any amounts resulting from the
revaluation of assets
What factors may cause a change in equity?
Change in equity may come from different sources:
- From profit-making activities, though some profit may be paid to shareholders as dividends
- Dividends will reduce the overall equity of the company - From shareholders contributing more money through share purchase
- New share capital will increase the overall equity of the company - From revaluation of non-current assets
- An increase in the value of assets does not count as profit, although it increases the amount of equity
Why do companies collapse?
Companies collapse when they are unable to
meet financial liabilities
ie Does the company have the money (resources)
to pay bills?
What is the current ratio?
Do current assets (CA) cover current liabilities (CL)?
Current ratio = CA/CL
What is the liquidity ratio (Acid Test)?
One may exclude inventories from CA to assess liquidity
Liquidity ratio (Acid Test) = (CA-Inventories)/CL
What is the gearing ratio?
Does the company have too much long term liabilities when compared to level of equity (is the company highly geared?)
Gearing ratio = long-term borrowings/(long-term borrowings + equity)
What is interest times cover?
However, it is also worth comparing the amount of interest with income
Interest times cover = income/interest
What are some of the limitations of the statement of financial position?
- What items to include in the statement
-E.g. the boundary between “capital expenditure”
and “revenue expenditure” is not clear - How to establish a value of assets to include
more intangible items - The real value of the business depends on the ability to generate income and not on the individual asset and liability values
-The value of a company as a whole is likely to be different from the total net value of the individual assets and liabilities. A successful business as a whole is usually worth much more than the total of its net assets
