CHAPTER 2

Statement of Financial Position – Formal statement showing the three elements comprising financial
position, namely A, L, E.

Liquidity – Entity’s ability to meet current maturing obligations.

Solvency – Availability of cash over the longer term to meet maturing obligations.

 Info about liquidity and solvency is useful in predicting the entity’s ability to comply with future
financial commitments and to pay dividends to shareholders.
 Current and Noncurrent Assets and Liabilities be presented as separate classifications in the
statement of Financial Position.

Asset – Present economic resource controlled by the entity as a result of past events.

- Properties Owned

- Characteristics: (a) Controlled by entity, (b) Result of past event, (c) Has potential to produce
economic benefits.

Economic Resource – Right that has the potential to produce economic benefits.

Current Asset Classification: (1) Cash/Cash Equivalents, (2) Held for purpose of trading,(3) Expected to
realize w/in 12 months, (4) Expected to realize, intent to sell, consume.

Cash & Cash Equivalents – short-term, highly liquid investments, readily convertible to cash, subject
to significant risk of changes in value.

- Cash on Hand, Petty Cash Fund, Cash in Bank

 Preference shares w/ specified redemption date and acquired 3 months before redemption date
can qualify as cash equivalent.

Financial asset’s classified as HELD FOR TRADING when:

1. Acquired principally for purpose of selling in near term

2. On initial recognition, it’s part of a portfolio of identified financial instruments that are managed
together and for which there is evidence of a recent actual pattern of short-term profit taking.

3. Derivative

Short-Term Notice Nontrade Receivables – Expected to be realized w/in 12 months.

Nontrade Receivables – Claims arising from sources other than the sale of merchandise/services in the
ordinary course of the business.

Realized, Sold or Consumed – (a) Trade Receivables, (b) Inventories, (c) Prepayments

Operating Cycle - Time between acquisition of assets for processing and their realization in cash/cash
equivalents.
 - Average time takes to acquire merchandise inventory, sell and collect cash.

- Basis of determining proper classification of asset into either current or noncurrent.

 Current assets are listed in order of liquidity.

Noncurrent Asset – Residual definition.

Property, Plant and Equipment – Tangible assets held for production, supply, rental or admin
purposes, and expected to be used during more than 1 period.

- Characteristics: (a) Tangible. W/ physical substance, (b) Used in production, supply, rental,
admin purposes, (c) Expected to be used over a period of more than 1yr.

Investment – Asset held by an entity for the accretion of wealth through capital distribution.

Current Investment – Investment that is by nature readily recognizable. Intended to be held for not
more than 1 year.

Long Term Investments Examples: (a) Investments in shares, (b) Bonds, (c) Subsidiaries, (d)
Associates, (e) Funds such as sinking fund, property, joint venture

Intangible Asset – Identified nonmonetary asset without physical substance.

- Characteristics: (a) Separable, Capable of being sold, transferred, licensed, rented or exchanged
separate from the entity, (b) Arises from contractual or other legal right.

Liability – Present obligation to transfer for an economic resource, as a result of past events.

Current Liability

- Characteristics: (a) Expected to be settled w/in entity’s normal operating cycle, (b) Held for
purpose of trading, (c) Due to be settled w/in 12 months after reporting period, (d) Does not have an
unconditional right to defer settlement of the liability for at least 12 months after the reporting period.

- Trade Payable, accruals, Bank Overdraft, Dividends Payable, Income Taxes, Financial Liabilities
held for trading.

 Refinancing/Rolling over must be at the discretion of the entity.

Covenants – Often attached to borrowing agreements which represent undertaking by borrower.

- Under these, condition relating a borrower’s financial situations are breached, liability becomes
payable on demand.

Noncurrent Liability – If lender has agreed on or before the end of reporting period to provide a grace
period ending at least 12months after the end of reporting period.

Grace Period – Period within which the borrower can rectify the breach and during which the lender
cannot demand immediate payment.
Financial Position Line Items for Current Liabilities:(1) Trade and other payables, (2) Current Provisions,
(3)Short-Term Borrowing, (4) Current Portion of Long-Term Debt, (5) Current Tax Liability

Entity’s Liquidity – Primary concern to most statement users.

Working Capital – Excess of current assets over current liabilities.

Working Capital Ratio – Current assets divided by current liabilities.

Estimated Liabilities – Obligations existing at the end of reporting period although the amount is
indefinite.

Contingent Liability – Possible obligation arising from past event and whose existence will only be
confirmed by the occurrence and nonoccurrence of one/more uncertain future event.

Range of Outcome: (a) Probable-more than 50%, (b) Possible- 50% or less, (c) Remote- 10% or
less.

Contingent Liability – Not recognized in the financial statements. Disclosed only.

- Either probable or measurable.

Provision – Present obligation is probable and amount can be measured.

- Expense and estimated liability shall be recorded in recognition.

Contingent Asset – Possible asset arising from past event and whose existence will be confirmed only
by the occurrence or nonoccurrence of one or more uncertain future events.

 Contingent asset shall not be recognized for this may result to recognition of income that may
never be realized.

Outcomes of a contingent asset: (a) Recognized when realized, (b) Only disclosed when probable, (c) If
possible, no disclosure required, (d) If remote, no disclosure.

Equity – Residual interest in the assets of the entity after deducting all of the liabilities.

- Net Assets/Total Assets ─ Liabilities

- Increased by profitable operations and contribution by owners.

Stockholders’/Shareholders’ Equity – Residual interest of owners in the net assets of a corporation

measured by the excess of asset over liabilities.

Share Capital – Portion of the paid in capital representing the total par or stated value of the shares
issued.

Subscribed Share Capital – Portion of the authorized share capital that has been subscribed but not
yet fully paid and therefore still unissued.

Subscriptions Receivable – Preferably be reflected as a deduction from the related subscribed share
capital.
Share Premium – Capital contributed by the shareholders in excess of the par or stated value of the
shares subscribed and issued.

Retained Earnings – Represent the cumulative balance of periodic net income or loss, dividend
distributions, prior period errors, changes in accounting policy and other capital adjustments.

Unappropriated Retained Earnings – Represent that portion which is free and can be declared as
dividends to the shareholders.

Appropriated Retained Earnings – Represent portion which is restricted and therefore not available
for any dividend declaration.

Deficit – Debit balance in retained earnings.

- Not presented as an asset but deduction from shareholders’ equity.

Revaluation Surplus – Excess of sound value over carrying amount of the revaluated asset.

Sound Value – Equal to fair value/depreciated replacement cost.

Depreciated Replacement Cost – Equal to replacement cost minus accumulated depreciation.

Carrying Amount – Computed by deducting accumulated depreciation on cost from historical cost.

Treasury Shares- Entity’s own shares that have been issued and then reacquired but not canceled.

- Recorded at cost not recognized as asset.

 Cost of treasury shares shall be reported as a deduction from Shareholders’ Equity.

 When acquired, retained earnings must be appropriated to the extent of the cost of the treasury
shares.

Distributable Equity – Portion that can be distributed to shareholders as dividends w/out impairing the
legal capital of the entity.

- Squarely pertains to unappropriated retained earnings.

Nondistributable Equity – Portion that cannot be distributed to the shareholders in any form during
the lifetime of the entity.