ACW 1020

Key points for Week 3 topic

Measuring and reporting financial position (Balance Sheet)

To get the most from your online learning and resources, you are strongly encouraged to make your
own note. By actively identifying the critical points while you are studying this week’s content, you
are reaffirming your understanding of the topic. You will find your notes would be very useful for
your revision for the tests or exam. You can use the following key points to start making your notes.

1. The nature and role of Balance Sheet

 It reports the assets, liabilities and shareholders’ equity
 The purpose of the balance sheet is to set out the financial position of a business at a
specific point in time
 Contains a snapshot of what a company owns and owes, as well as the amount invested by
owners
 Accounting equation

2. Assets (A resource held by a business which has certain characteristics)

 4 characteristics of assets in accounting
A probable future economic benefit
The business has an exclusive right to control the benefit
The benefit must arise from some past transaction or event
The asset must be capable of reliable measurement in monetary terms
 Examples of assets
Tangible assets=those assets that have a physical substance (e.g. plant and machinery)
Intangible assets= assets which, while providing expected future benefits, have no
physical substance (e.g. copyrights, patents(the granting of a property right by a
sovereign authority to an investor))
 Classifications of assets
Assets are classified as current where:
o They are held for sale or consumption during the business’s normal operating
cycle
o They are expected to be sold within the next year
o They are held principally for trading, and/or
o They are cash, or near-cash (such as easily marketable, short-term investments)

All other assets are classified as non-current

 Measurement of non-current assets

Historical cost= the original price/cost when the asset was acquired by the company
Fair value= provided fair value can be reliably estimated
Fair value means the current market value (i.e. the exchange value in an
arm’s length transaction
 Non-current assets have lives that are either finite or indefinite
  Non-current assets with finite lives –as there assets are used up over time, their cost
is recognised as an expense in each period (depreciation or amortisation)(Historical
cost or Fair value)
 Non-current assets with indefinite lives –assets not used up over time so not subject
to routine annual depreciation over time (Historical cost or Fair value)

3. Liabilities (claims of individuals and organisations, apart from the owner(s), that have arisen
from past transactions or events, such as supplying goods or lending money to the business)
“Liabilities” are the probable future sacrifices of economic benefits that the entity is presently
obliged to make to other entities as a result of past transactions or other past events and the
amount of the liability can be measured reliably.
 4 characteristics of liabilities in accounting
Liabilities are classified as current where:
o They are expected to be settled within the business’s normal operating cycle
o They are held principally for trading purposes
o They are due to be settled within a year after the date of the relevant statement
of financial position, and/or
o There is no right to defer settlement beyond a year after the date of the relevant
statement of financial position
 All other liabilities are classified as non-current
 Examples of liabilities
 Classifications of liabilities
Current liabilities
o Account payable – This is money owned to suppliers
o Accrued expenses – These are monies due to a third party but not yet payable;
for example, wages payable
 o Unearned revenue –These are payments given by customers as an advance for
future work that is expected to be completed by the end of the next 12 months
 Non-current liabilities
o Mortgage loans – a loan which has an asset to serve as collateral to secure
the loan
o Bonds payable – a loan made by a business to other corporations or
governments, to finance projects and operations

4. Equity
 Definition of equity
Represents the claim of the owner(s) against the business
In accounting, it is defined as ‘residual interest in the assets of the entity after deducting
all its liabilities’
Equity – the owner’s investment in the business. Can increase due to profit and reduce
because of drawings made by the owners.
Examples of equity:
o Share capital
o Retained earnings
o Dividend
 Components of equity
 Retained earning
The amount of money earned through regular course of business that is retained from
year to year
Use for
o Pay out dividends
o Reinvest into other business ventures
o Finance other areas of their operation

Retained earnings is reported in Stockholders Equity section on the balance sheet

Beginning retained earning + Net Income – Dividends = Ending Retained Earnings

 Dividend
A sum of money paid regularly (typically annually) by a company to its shareholders
out of profit (or reserves)

5. Usefulness and limitations

Usefulness of the Balance Sheet

o Provides insights about how the business is financed and how its funds are deployed
o Provides insights into the liquidity of the business
o Can provide a basis for assessing the value of the business
o Provides insights into the ‘mix’ of assets held by the business
o It can help users in assessing performance
Limitations of the Balance Sheet

o Most items recorded at historical cost (As a result, the shareholder’s equity which
represents the net worth of a company, on many occasions, does not reflect the true value
of the firm)
o Estimates (warranty, bad debt)
o Omissions (brand value)
o Off balance sheet financing (debt)

Despite its limitations, balance sheet is always considered as a critical component in a financial
statements.

As a part of their research, analysts and investors refer to balance sheets to learn about the financial
positions of companies.

Of course, they will use other sources of information to complement the information reported by a
balance sheet.

Claim= an obligation on the part of the business to provide cash or some other benefit to an outside
party

Owners’ equity= the claim of the owner(s) on the assets of the business

Equity/capital= the share of the business which represents the owners’ interests