Elements of the Statement of Financial Position

The statement of financial position provides a snapshot of an organisation’s assets, liabilities and capital balances at a specified date.

Assets

Liabilities

Generally, a liability is an amount that is owed by the business. Liabilities imply legal responsibilities or duties to other parties.

Liabilities can be split into two categories: current and non-current.

Per IFRS 18, an entity should classify a liability as current when:

1. it expects to settle the liability in its normal operating cycle;
2. it holds the liability primarily for the purpose of trading;
3. the liability is expected to be settled within 12 months after the reporting period; or
4. it does not have the right at the end of the reporting period to defer settlement of the liability for at least 12 months after the reporting period.

• Current liabilities – usually they are amounts owed by the business falling due for payment within one year of the reporting date. For example, amounts due to suppliers for goods purchased on credit are trade payables.
• Non-current liabilities – are all liabilities that are not classified as current. This mainly consists of amounts owed by the business falling due for payment beyond one year from the reporting date (total liabilities − current liabilities).

Entities are frequently financed by credit from sources other than the owners, which gives rise to liabilities.

Assets can be split into two categories: current assets and non-current assets.

Per IFRS 18, an entity should classify an asset as current when:

1. it expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
2. it holds the asset primarily for the purpose of trading;
3. it expects to realise the asset within 12 months after the reporting period; or
4. The asset is cash or a cash equivalent (as defined in IAS 7).

• Current assets – include cash at bank, amounts due from customers, and goods held for resale.

• Non-Current Assets – are all other assets that do not meet any of the criteria above that would make them current assets. For example, offices, shops, warehouses, delivery vehicles and production equipment.

  Non-current assets can be further split into two: tangible and intangible.

  • Tangible non-current assets are non-current assets that have a physical form and can be touched. For example, machinery, fixtures and fittings, and computer equipment.
  • Intangible non-current assets are non-current assets that do not have a physical form. For example, software licences purchased for use by the business for more than 12 months.

It is essential to understand the different categories of assets as current and non-current assets are presented separately in the statement of financial position.

Liabilities

Generally, a liability is an amount that is owed by the business. Liabilities imply legal responsibilities or duties to other parties.

Liabilities can be split into two categories: current and non-current.

Per IFRS 18, an entity should classify a liability as current when:

1. it expects to settle the liability in its normal operating cycle;
2. it holds the liability primarily for the purpose of trading;
3. the liability is expected to be settled within 12 months after the reporting period; or
4. it does not have the right at the end of the reporting period to defer settlement of the liability for at least 12 months after the reporting period.

• Current liabilities – usually they are amounts owed by the business falling due for payment within one year of the reporting date. For example, amounts due to suppliers for goods purchased on credit are trade payables.
• Non-current liabilities – are all liabilities that are not classified as current. This mainly consists of amounts owed by the business falling due for payment beyond one year from the reporting date (total liabilities − current liabilities).

Entities are frequently financed by credit from sources other than the owners, which gives rise to liabilities.

Activity 1

For each statement below, state whether they are True or False.

1. A laptop that is used daily is a current asset.
2. A machine used to create products is a tangible non-current asset.
3. A software licence that allows a business to use specific software for a period of three years is a tangible non-current asset.
4. A truck a business uses to deliver goods to its customers is a tangible non-current asset.
5. Goods purchased by a business for resale to its customers are tangible non-current assets.v
   1. it expects to settle the liability in its normal operating cycle;
   2. it holds the liability primarily for the purpose of trading;
   3. the liability is expected to be settled within 12 months after the reporting period; or
   4. it does not have the right at the end of the reporting period to defer settlement of the liability for at least 12 months after the reporting period.
   • Current liabilities – usually they are amounts owed by the business falling due for payment within one year of the reporting date. For example, amounts due to suppliers for goods purchased on credit are trade payables.
   • Non-current liabilities – are all liabilities that are not classified as current. This mainly consists of amounts owed by the business falling due for payment beyond one year from the reporting date (total liabilities − current liabilities).

   Entities are frequently financed by credit from sources other than the owners, which gives rise to liabilities.

   For example, a loan received in 20X5, which is to be repaid in five years, will be a non-current liability in the 20X5 to 20X8 statements of financial position, with a year’s portion in current liabilities. In the 20X9 financial statement, the total balance owing will be classified as a current liability.

   Capital/ Equity

   Definition
   Equity is the residual interest in the assets of the entity after deducting its liabilities.

   It is the difference between total assets and total liabilities:

   Total Assets – Total Liabilities

   It amounts to the total investment in a business entity (a proprietor’s or shareholders’ funds or capital) and is sometimes called the net worth.

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Elements of the Statement of Profit or Loss

As discussed in chapter 1, the statement of profit or loss includes:

1. Gross Profit – this is the profit from trading and is the excess of sales over the cost of goods sold during the period.
2. Profit – this is the remaining profit after all other income earned and expenses incurred in the period have been deducted from the gross profit.

The statement of profit or loss summarises the organisation’s financial performance during the financial year.

The statement of profit or loss and other comprehensive income for companies presents more detail in terms of performance for the year, including additional sub-totals for profit in between ‘gross profit’ (at the top) and ‘profit’ (at the bottom). See chapter 15 for details.

 Income

Income reflects all sales made to customers in the year, regardless of whether they have been paid for. Cash inflows from shareholders are not income.

• A sale is usually recognised as taking place when goods are dispatched (or services provided) to a customer.
• Sales made to customers on credit which have not been settled for cash at the reporting date are shown in the statement of financial position as trade receivables.
  

   Income

  Definition
  Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims. (IFRS Conceptual Framework)

  Income reflects all sales made to customers in the year, regardless of whether they have been paid for. Cash inflows from shareholders are not income.

• A sale is usually recognised as taking place when goods are dispatched (or services provided) to a customer.
• Sales made to customers on credit which have not been settled for cash at the reporting date are shown in the statement of financial position as trade receivables.

 Income

Income reflects all sales made to customers in the year, regardless of whether they have been paid for. Cash inflows from shareholders are not income.

• A sale is usually recognised as taking place when goods are dispatched (or services provided) to a customer.
• Sales made to customers on credit which have not been settled for cash at the reporting date are shown in the statement of financial position as trade receivables.

 Income

Income reflects all sales made to customers in the year, regardless of whether they have been paid for. Cash inflows from shareholders are not income.

• A sale is usually recognised as taking place when goods are dispatched (or services provided) to a customer.
• Sales made to customers on credit which have not been settled for cash at the reporting date are shown in the statement of financial position as trade receivables.

 Income

Income reflects all sales made to customers in the year, regardless of whether they have been paid for. Cash inflows from shareholders are not income.

• A sale is usually recognised as taking place when goods are dispatched (or services provided) to a customer.
• Sales made to customers on credit which have not been settled for cash at the reporting date are shown in the statement of financial position as trade receivables.

Expenses

An expense of a business is a day-to-day cost incurred in operating the business. Payments to shareholders (such as dividends) are not expenses.

• Cost of sales is the cost of goods that have been sold. It includes all the costs connected with the purchase and manufacture of goods. Costs incurred are matched with revenues earned.
•  Other expenses can include various costs such as electricity, rent, salaries, and interest  paid.

Expenses

An expense of a business is a day-to-day cost incurred in operating the business. Payments to shareholders (such as dividends) are not expenses.

• Cost of sales is the cost of goods that have been sold. It includes all the costs connected with the purchase and manufacture of goods. Costs incurred are matched with revenues earned.
• Other expenses can include various costs such as electricity, rent, salaries, and interest paid.

Activity 2

In the following activity, classify the list of items into the elements of financial statements.

1. Shareholder’s investment
2. Computers
3. Bookkeeper’s annual salary
4. Warehouse
5. Unsold goods
6. Overdraft with the bank
7. Cash held at the bank
8. Sales of goods for cash in the factory shop

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Asset (Capitalised) Expenditure versus Expenses

When an item of expenditure is incurred, a decision must be made whether it affects the:

• Statement of financial position, as asset (capitalised) expenditure; or

• Ethics

  The distinction between expenses and asset expenditure is essential in the real world. If a business incorrectly classified an expense as asset expenditure, it would lead to expenses being understated and profits being overstated. This would mean that the profit would not fairly represent the performance of the business. Asset Expenditure Asset expenditure relates to the purchase of non-current assets. Asset expenditure is incurred in: Acquiring property and equipment for long-term use (the business benefits from the use of the asset in the current and in future accounting periods). Increasing the revenue-earning capacity of an existing non-current asset (by increasing its efficiency or useful life). Items of asset expenditure (except for the cost of land) will ultimately be charged to profit or loss (through depreciation) as the asset is consumed through its use in the business. Expenses Expenses, commonly called operating expenses, are incurred in the daily running (operation) of the business. Examples include: buying or manufacturing goods which are sold providing services selling and distributing goods administration costs repairing long-term assets These costs are immediately charged to profit or loss and matched with the accounting period’s revenues Activity 3 Classify the following items of expenditure as asset expenditure or expenses charged to profit or loss: $27,000 on the purchase of a new car. $1,800 road tax incorporated in the car’s purchase price in (1) above. $10,000 on a second-hand delivery van. $12,000 on refurbishing the delivery van in (3) above. $1,000 monthly rental of a vehicle. *Please use the notes feature in the toolbar to help formulate your answer. Activity 4 Rubin owns a business that sells office and computer equipment to corporate customers. His business operates from a warehouse and has a small fleet of delivery vehicles. Determine whether the expenditure incurred by Rubin’s business should be classified as an expense or asset expenditure. Rubin’s business has bought some laptops and speakers from its suppliers, which will be sold to its customer. Rubin’s accountant prepares its financial statements. She ordered a photocopier to make copies of her paperwork. Rubin’s business is expanding, and he has rented a new warehouse. Rubin ensures that all the vehicles have valid insurance. Each time he orders a new vehicle, he insures it immediately. Goods are delivered to customers using one of the business’s delivery vehicles. On the way back to the warehouse, the driver crashes the side of the vehicle into the fence. The vehicle will need to be fixed to be used again. Rubin’s business orders a few new vehicles to keep up with customer orders. *Please use the notes feature in the toolbar to help formulate your answer The Duality Concept The duality concept is the fundamental accounting principle upon which the recording of financial information is based. It states that every transaction must be recorded twice in the accounting records, and is the reason for the name ‘double-entry bookkeeping’. When a transaction is recorded, the second effect is equal to, and the opposite of, the first effect. Activity 5 Match the transactions to the corresponding duality statements. Transaction Duality Statement Sell goods for cash Sales income increases, and trade receivables asset increases. Sell goods on credit Trade payables liability decreases, and bank asset decreases. Purchase goods for resale for cash Goods for resale expense increase, and bank asset decreases. Purchase goods for resale on credit Capital introduced increases and bank asset increases. Pay a supplier for some equipment bought on credit Sales income increases, and bank asset increases. Purchase some equipment for cash Equipment asset increases, and bank asset decreases. Start the business by introducing cash Goods for resale expense increases, and trade payables liability increases. *Please use the notes feature in the toolbar to help formulate your answer. The duality concept is the fundamental accounting principle upon which the recording of financial information is based. It states that every transaction must be recorded twice in the accounting records, and is the reason for the name ‘double-entry bookkeeping’. When a transaction is recorded, the second effect is equal to, and the opposite of, the first effect The Accounting Equation The elements of financial statements are assets, liabilities, capital (equity), income and expenses. These elements relate to one another, and their relationship is expressed in the accounting equation: Capital or Net Assets = Assets – Liabilities At any point in time when transactions have been recorded correctly, the accounting equation will always balance. The accounting equation can be manipulated to encompass every type of element of financial statements. The simple accounting equation is: Assets – Liabilities = Capital or Net Assets Capital is also known as net assets and belongs to the owner. It is the amount the owner invested minus any amounts that owners have taken out of the business (drawings) plus the profit made by the business. Closing Capital = Total Capital Introduced – Drawings + Profits Closing capital is the capital at the end of the accounting year Total capital introduced is the capital at the start of the accounting year plus any additional capital invested during the year Drawings are taken and profits or losses are achieved during the year The formula below shows the expanded accounting equation once the above elements are included: Key Point Assets – Liabilities = Total Capital Introduced – Drawings + Income – Expense Activity 6 Match item to the corresponding rearranged accounting equation. Item   Rearranged accounting equation Assets Opening capital + Profit for the period − Drawings Closing Net Assets Closing net assets − Opening net assets + Drawings Opening Net Assets Capital + Liabilities Closing Capital Assets − Capital Liabilities Closing net assets − Profit for the period + Drawings Profit for the period Closing capital *Please use the notes feature in the toolbar to help formulate your answer. The Accounting Equation and Double-Entry Bookkeeping A transaction recorded using double-entry bookkeeping will always cause the accounting equation to balance. This is due to the dual impact of double-entry, where each transaction is recorded using a debit (Dr) and a credit (Cr) entry which are equal to and the opposite of each other. The effect of a debit or a credit entry on the balance of an account (whether it increases or decreases it) depends on the category of the account. The expanded accounting equation can be rearranged as follows: Assets + Drawings + Expenses = Capital + Liabilities + Income Assets, drawings and expenses normally have debit balances. A debit entry in any of these accounts will increase the balance in that account (and a credit entry will reduce the balance). Whereas capital, liabilities and income normally have credit balances. A credit entry in any of these accounts will increase the balance in that account (and a debit entry will reduce the balance). Category A debit entry will… A credit entry will… Asset Increase an asset Decrease an asset Liability Decrease a liability Increase a liability Income Decrease income Increase income Expense Increase an expense Decrease an expense Capital Decrease capital Increase capital Drawings Increase drawing Decrease drawing Statement of profit or loss, as an expense.

  v

  Example 1

  Yuma owns a business that makes and delivers handmade furniture to customers. What is the effect of the transaction on the business and the double-entry to record the transaction? She buys a vehicle for the business and pays $5,000 using funds from the bank. The vehicle (Asset) increases by $5,000, and the bank (Asset) decreases by $5,000. The double-entry to record this is DR Vehicles $5,000 and CR Bank $5,000. She obtains a loan of $2,000 from a friend. The bank (Asset) increases by $2,000, and the loan (Liability) increases by $2,000. The double-entry to record this is DR Bank $2,000 and CR Loan $2,000. She buys office furniture paying $500 cash. The office furniture (Asset) increases by $500, and the bank (Asset) decreases by $500. The double-entry to record this is DR Office Furniture $500, and CR Bank $500. She pays a supplier for chairs and a table bought on credit for $1,200 credit. The trade payable (Liability) decreases by $1,200, and the bank (Asset) reduces by $1,200. The double-entry to record this is DR Trade payables $1,200 and CR Bank $1,200. She purchases a batch of raw materials paying $800 cash. The purchases (Expense) increase by $800, and the bank (Asset) decrease by $800. The double-entry to record this is DR Purchases $800 and CR Bank $800. Yuma pays rent in cash of $2,000 for the year. The rent (Expense) increases by $2,000, and the bank (Asset) decreases by $2,000. The double-entry to record this is DR Rent $2,000, and CR Bank $2,000. Example 2 Consider the following transactions, their effect on the accounting equation and the double-entry to record each transaction. Transaction 1: The owner put $20,000 into the business. The money has been paid into the business bank account. The accounting equation looks like this: Assets − Liabilities = Capital Bank $20,000 − 0 = $20,000 The cash in the bank now belongs to the business (asset), and the business has a responsibility at some point to pay that amount back to the owners (capital). (Asset increased, Capital increased) The double-entry to record this is DR Bank $20,000, and CR Capital $20,000. Example 2 Consider the following transactions, their effect on the accounting equation and the double-entry to record each transaction. Transaction 1: The owner put $20,000 into the business. The money has been paid into the business bank account. The accounting equation looks like this: Assets − Liabilities = Capital Bank $20,000 − 0 = $20,000 The cash in the bank now belongs to the business (asset), and the business has a responsibility at some point to pay that amount back to the owners (capital). (Asset increased, Capital increased) The double-entry to record this is DR Bank $20,000, and CR Capital $20,000. Activity 7 What is the double entry to record the following transactions? Starts the business by introducing cash. Purchases some equipment for cash. Pays a supplier for some equipment bought on credit. Purchases goods for resale on credit. Purchases goods for resale for cash. Sells goods on credit. Sells goods for cash. *Please use the notes feature in the toolbar to help formulate your answer.v Activity 7 What is the double entry to record the following transactions? Starts the business by introducing cash. Purchases some equipment for cash. Pays a supplier for some equipment bought on credit. Purchases goods for resale on credit. Purchases goods for resale for cash. Sells goods on credit. Sells goods for cash. *Please use the notes feature in the toolbar to help formulate your answer..v Activity 7 What is the double entry to record the following transactions? Starts the business by introducing cash. Purchases some equipment for cash. Pays a supplier for some equipment bought on credit. Purchases goods for resale on credit. Purchases goods for resale for cash. Sells goods on credit. Sells goods for cash. *Please use the notes feature in the toolbar to help formulate your answer. Syllabus Coverage This chapter covers the following Learning Outcomes. A. The context and purpose of financial reporting The main elements of financial statements Identify and define assets, liabilities, equity, income and expenses. C The use of double-entry bookkeeping and accounting systems Double-entry bookkeeping principles including the maintenance of accounting records Explain and apply the accounting equation. D Recording transactions and events Tangible non-current assets Define non-current assets. Compare the difference between current and non-current assets. Explain the difference between asset (capitalised) and expense items. Classify expenditure as asset expenditure or expenses charged to profit or loss. Intangible non-current assets and amortisation Compare the difference between tangible and intangible non-current assets. G. Preparing financial statements Statement of financial position Explain how the accounting equation, IFRS Accounting Standards and the business entity concept underlie the statement of financial position. Syllabus Coverage This chapter covers the following Learning Outcomes. A. The context and purpose of financial reporting The main elements of financial statements Identify and define assets, liabilities, equity, income and expenses. C The use of double-entry bookkeeping and accounting systems Double-entry bookkeeping principles including the maintenance of accounting records Explain and apply the accounting equation. D Recording transactions and events Tangible non-current assets Define non-current assets. Compare the difference between current and non-current assets. Explain the difference between asset (capitalised) and expense items. Classify expenditure as asset expenditure or expenses charged to profit or loss. Intangible non-current assets and amortisation Compare the difference between tangible and intangible non-current assets. G. Preparing financial statements Statement of financial position Explain how the accounting equation, IFRS Accounting Standards and the business entity concept underlie the statement of financial position. Syllabus Coverage This chapter covers the following Learning Outcomes. A. The context and purpose of financial reporting The main elements of financial statements Identify and define assets, liabilities, equity, income and expenses. C The use of double-entry bookkeeping and accounting systems Double-entry bookkeeping principles including the maintenance of accounting records Explain and apply the accounting equation. D Recording transactions and events Tangible non-current assets Define non-current assets. Compare the difference between current and non-current assets. Explain the difference between asset (capitalised) and expense items. Classify expenditure as asset expenditure or expenses charged to profit or loss. Intangible non-current assets and amortisation Compare the difference between tangible and intangible non-current assets. G. Preparing financial statements Statement of financial position Explain how the accounting equation, IFRS Accounting Standards and the business entity concept underlie the statement of financial position.v Syllabus Coverage This chapter covers the following Learning Outcomes. A. The context and purpose of financial reporting The main elements of financial statements Summary and Quiz There are FIVE elements of financial statements: Asset Liability Equity Income (including gains) Expense (including losses) Statement of Financial Position: Elements include assets, liabilities and equity (capital). It provides information on the resource structure of an entity (i.e. the primary classes and amounts of assets). Assets are presented to help users assess the liquidity of available resources. Assets held continuously for use are shown separately from current assets. It is a static statement prepared “as at” a specified date. It does not show the value of a business. Statement of Profit or Loss and other comprehensive income: A single statement or two statements (i.e. profit or loss + other comprehensive income). Other comprehensive income includes gains and losses not recognised in profit or loss (e.g. a revaluation surplus). Statement of profit or loss The trading account shows the gross profit for the accounting period. Gross profit is sales (revenue) less the cost of goods sold. Revenue is recognised even though cash may have yet to be received. Cost of goods sold is calculated as: Opening inventory x   + Purchases x   − Closing inventory (x) (i.e. goods not sold) = Cost of goods sold x   “Profit or loss” is a descriptive term for the bottom line of this statement. A business entity is separate from its owners for accounting purposes even if it is not a separate legal entity. All transactions with owners are accounted for from the standpoint of the business. Every transaction has “an equal and opposite” effect. At any point: Total assets − Total liabilities = Equity Total assets = Equity + Total liabilities Under IFRS Accounting Standards, the presentation of the statement of financial position is an expansion of (ii). Equity = Capital + Retained earnings Identify and define assets, liabilities, equity, income and expenses. C The use of double-entry bookkeeping and accounting systems Double-entry bookkeeping principles including the maintenance of accounting records Explain and apply the accounting equation. D Recording transactions and events Tangible non-current assets Define non-current assets. Compare the difference between current and non-current assets. Explain the difference between asset (capitalised) and expense items. Classify expenditure as asset expenditure or expenses charged to profit or loss. Intangible non-current assets and amortisation Compare the difference between tangible and intangible non-current assets. G. Preparing financial statements Statement of financial position Explain how the accounting equation, IFRS Accounting Standards and the business entity concept underlie the statement of financial position.v Summary and Quiz There are FIVE elements of financial statements: Asset Liability Equity Income (including gains) Expense (including losses) Statement of Financial Position: Elements include assets, liabilities and equity (capital). It provides information on the resource structure of an entity (i.e. the primary classes and amounts of assets). Assets are presented to help users assess the liquidity of available resources. Assets held continuously for use are shown separately from current assets. It is a static statement prepared “as at” a specified date. It does not show the value of a business. Statement of Profit or Loss and other comprehensive income: A single statement or two statements (i.e. profit or loss + other comprehensive income). Other comprehensive income includes gains and losses not recognised in profit or loss (e.g. a revaluation surplus). Statement of profit or loss The trading account shows the gross profit for the accounting period. Gross profit is sales (revenue) less the cost of goods sold. Revenue is recognised even though cash may have yet to be received. Cost of goods sold is calculated as: Opening inventory x   + Purchases x   − Closing inventory (x) (i.e. goods not sold) = Cost of goods sold x   “Profit or loss” is a descriptive term for the bottom line of this statement. A business entity is separate from its owners for accounting purposes even if it is not a separate legal entity. All transactions with owners are accounted for from the standpoint of the business. Every transaction has “an equal and opposite” effect. At any point: Total assets − Total liabilities = Equity Total assets = Equity + Total liabilities Under IFRS Accounting Standards, the presentation of the statement of financial position is an expansion of (ii). Equity = Capital + Retained earnings