Week 4: Learning Objectives

PowerPoint to accompany
Learning Objectives
• Explain the nature and purpose of the balance sheet
Week 4 • Demonstrate an understanding of assets in terms of
definition, recognition, measurement and
classification
Measuring and • Demonstrate an understanding of liabilities in terms
Reporting Financial of definition, recognition, measurement and
Position classification
Text: Chapter 3 • Discuss the nature and classification of owner’s
equity
• Explain the basic accounting equation
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia
Nature and Purpose of a Balance

Learning Objectives cont’d Sheet
Learning Objective: Explain the nature and purpose of the
• Contrast the alternative balance sheet formats balance sheet
• The purpose of the balance sheet is to set out the
• Discuss the main factors that influence the content
financial position of a business at a particular point in
and values in a balance sheet time
• Prepare a simple balance sheet • It contains a snap shot of the assets, liabilities and
• Analyse balance sheets of reporting entities equity position of the entity at a particular point in
time
• State the potential limitations of the balance sheet in
• As from January 2009 an accounting standard
portraying an entity’s financial position recommendation is that the balance sheet should be
referred to as a ‘statement of financial position’
Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia
Assets Assets cont’d

The main identifying characteristics of an asset are:
Learning Objective: Demonstrate and understanding of
assets in terms of definition, recognition, measurement • Expected future economic benefit
and classification
• The business has exclusive right to control the
benefit
Definition:
• The benefit must arise from some past transaction
Asset: (AASB Framework) “A resource controlled by or event
the entity as a result of past events, and from which
economic benefits are expected to flow to the entity” • The asset must be capable of reliable
measurement in monetary terms
Note that these conditions limit the kind of items that may be
referred to as ‘assets’ in financial reports

Assets cont’d Claims Against the Assets
Some examples of items that appear as assets in a There are essentially two types of claims against the
business balance sheet include: assets of an entity:
• Freehold premises
• Machinery and equipment • External claims - known as liabilities
• Fixtures and fittings • Internal claims - labelled owners’ equity, equity,
• Patents and trademarks or capital
• Debtors
• Investments Owners’ equity - The claim of the owner(s) on the
assets of the business
Assets may be either tangible (items with a physical
substance) or intangible (no physical substance eg patents)
Liabilities Liabilities cont’d

Learning Objective: Demonstrate an understanding of
liabilities in terms of definition, recognition, measurement In addition to meeting the definition on the previous
and classification
slide, there is a twofold recognition criteria:
Definition:
• Probability of occurrence (in the case of liabilities,
Liability: (AASB Framework) “A present obligation
of the entity arising from past events, the settlement it is more likely than not that a future sacrifice of
of which is expected to result in an outflow from the economic benefits will occur)
entity of resources embodying economic benefits”
• Reliability of measurement (in the case of
liabilities the amount of the claim can be
determined with acceptable precision or
accuracy)
Liabilities cont’d Owners’ Equity (OE, or ‘Equity)

Some examples of items that appear as liabilities in a Learning Objective: Discuss the nature and classification
business balance sheet include: of owners’ equity
• Creditors Definition:
• Staff entitlements • The claim of the owner(s) against the business
• Loans and other credit facilities
• Warranty provisions and other social or moral • AASB Framework defines equity as the “residual
obligations interest in the assets of the entity after deducting
• Provision for employee bonuses or owners’ all its liabilities.”
distribution

Owners’ Equity cont’d The Accounting Equation
On the balance sheet, there are two additional Learning Objective: Explain the basic accounting equation
accounts to the owner’s equity contributed account:
• Owner’s equity retained - represents profits left The basic accounting equation is expressed as:
in the business by the owners
• Reserves - represent ‘special purpose’ owners’ Assets = Owners’ equity + Liabilities
equity accounts e.g. ‘Capital profits reserve’
Note: Reserves represent ownership interests in the assets,

This equation will always hold true, as total claims
not the assets themselves. Reserves are not separate are always the same as total assets, ensuring that
deposits of cash available for other purposes. the balance sheet always ‘balances’
Effect of Trading Operations on the

Balance Sheet Jerry and Company Eg. 3.1
Trading introduces additional transactions to the – $20,000 deposited in bank account to commence
balance sheet. business on March 1. Cash is supplied by the owner
($6,000) and outside lender ($14,000)
– March 2 - purchased a motor vehicle for $5,000
To cover the effect of trading, the balance sheet paying cash
equation previously described is extended as
– March 3 – purchased inventory on one months credit
follows: for $3,000
– March 4 – repaid $2,000 of the loan
Assets = Owners’ equity beginning – March 6 – owner introduced $4,000 into the
+ Profit (or - Loss) +/- Other business bank account
Owners’ Equity Changes + Liabilities – March 7 – business sold all inventory for $5,000 for
cash and owner withdrew $1,500 in cash
Accounting equation and effects of

transactions The Classification of Assets
Assets = Liabilities + Owners equity Learning Objective: Demonstrate an understanding of
Cash Inv MV Creditor Loan Capital RP Draw assets in terms of definition, recognition, measurement
20,000 14,000 6,000 and classification
-5,000 5,000
3,000 3,000 Assets are normally categorised as either current, or
-2,000 -2,000
non-current
4,000 4,000
5,000 -3,000 2,000
-1,500 -1,500 Current assets:
20,500 0 5,000 3,000 12,000 10,000 2,000 -1,500
• Are not held on a continuing basis
25,500 25,500
• Include cash and other assets expected to be consumed or
converted into cash within the operating cycle
• Also include inventory, trade debtors and pre-payments

Classification of Assets cont’d Classification of Assets cont’d
AASB 101 ‘Presentation of Financial Statements’ Non-Current assets:
requires a ‘current asset’ to be classified according to
the following criteria: • Held for the purpose of generating wealth, rather
than for resale
a) The asset is expected to be realised in, or is intended for • May be seen as the tools of the business
sale or consumption in, the entity’s normal operating
cycle; • Normally held on a continuing basis for a
b) The asset is held primarily for the purpose of being minimum period of one year
traded; • Includes ‘goodwill purchased’ - see page 90
c) The asset is expected to be realised within twelve months
after the reporting date; or AASB 101 ‘Presentation of Financial Statements’
d) The asset is cash or a cash equivalent unless it is requires assets to be classified as non-current if they
restricted from being exchanged or used to settle a do not satisfy any of the criteria for being classified as
liability for at least twelve months after the reporting date
current (previous slide)
Classification of Liabilities Classification of Liabilities cont’d

Learning Objective: Demonstrate an understanding of AASB 101 ‘Presentation of Financial Statements’
liabilities in terms of definition, recognition, measurement requires a liability to be classified as current when it
and classification satisfies the following criteria:
a) The liability is expected to be settled in the entity’s normal

Liabilities are normally categorised as either current operating cycle;
or non-current b) The liability is held primarily for the purpose of being
traded;
Current liabilities: c) The liability is due to be settled within twelve months after
the reporting date; or
• Amounts due for repayment to outside parties d) The entity does not have an unconditional right to defer
within 12 months of the statement of financial settlement of the liability for at least twelve months after
position date the reporting date
Classification of Liabilities cont’d Classification of Liabilities cont’d

Non-Current liabilities: AASB 101 ‘Presentation of Financial Statements’
• Those amounts due to other parties which are not also requires that liabilities be classified according to
liable for repayment within the next 12 months their nature. This classification can be on:
• Only the period for which the liability is
outstanding matters - not the purpose it is held for • Current / Non-Current basis, or
• The order of liquidity (payment)
AASB 101 ‘Presentation of Financial Statements’
requires liabilities to be classified as non-current if
they do not satisfy any of the criteria for being The alternative liquidity classification may be used
classified as current (previous slide) for liabilities if it provides more relevant and reliable
information

Classification of Owners’ Equity Formats for Balance Sheets
Learning Objective: Discuss the nature and classification Learning Objective: Contrast the alternative balance sheet
of owners’ equity formats
Owners’ equity is normally classified in three

Liabilities +
Current Non-Current Current
separate categories: Assets
+ Assets = Liabilities + Non-Current Owners’
Equity
1) Owners’ equity contributed
Figure 3.2 The Horizontal layout and entity approach
2) Reserves The equation for the horizontal form of balance sheet layout
3) Retained profit
Current Non-Current Current
It is common to combine categories 2 and 3 into Assets + Assets - Liabilities - Non-Current
Liabilities = Capital
‘other reserves’ with sub-categories (a) retained

profits and (b) other reserves Figure 3.3 The Vertical layout and proprietary approach
The equation for the vertical form of balance sheet layout
Factors Influencing the Form and Factors Influencing the Form and
Content of the Balance Sheet Content of the Balance Sheet
Learning Objective: Discuss the main factors that influence Conventional Accounting Practice:
the content and values on a balance sheet
• Made up of doctrines, principles, assumptions
There are three main influences on the accounts and accepted ideas on which accounting rules,
included in the balance sheet: records and reports were or are based
• These have collectively been known as GAAP
(Generally Accepted Accounting Principles /
1. Traditional accounting conventions and Practices)
doctrines
Business Entity Convention:
2. More recent theoretical developments in
conceptual framework projects • Holds that for accounting purposes, the business
and its owner(s) are treated as separate and
3. Professional and statutory accounting standards distinct
Money Measurement Convention: Dual Aspect Convention:
• Holds that accounting should only deal with those • Holds that each transaction has two aspects and
items which are capable of being expressed in that each aspect must be recorded in the financial
monetary terms statements
Historic Cost Convention: Conservatism / Prudence Convention:
• Holds that assets should be recorded at their • Holds that financial reports should err on the side
historic (acquisition) cost of caution vis-à-vis, anticipating losses but only
Going Concern (Continuity) Convention: recognising realised profits
• Holds that the business will continue operations See also: Stable monetary unit convention,
for the foreseeable future i.e. no intention or need Objectivity / reliability convention, Accounting
to liquidate the business period convention, Realisation convention and
Matching convention, detailed on pp 101 - 103

• The Conceptual Framework: • Accounting Standards:
• Four Statements of Accounting Concepts (SACs) • The history and significance of accounting standard
were current up until 2004, known as SACs 1 - 4 setting in Australia is covered in detail in chapter 2
• SAC 3 and SAC 4 have now been replaced by the
• Regarding the balance sheet, there are numerous
adoption of the AASB Framework, SAC 1 and SAC 2
standards that directly affect recording and reporting
continue in their previous form
assets, liabilities and owners’ equity
• While the framework and statements are not
mandatory, they have significant influence on new • The implications of the applicable Australian
and revised standards being issued Accounting Standards will continue to be considered
Basis of Valuation of Assets on Basis of Valuation of Liabilities

the Balance Sheet on the Balance Sheet
Learning Objective: Demonstrate an understanding of Learning Objective: Demonstrate an understanding of liabilities in
assets in terms of definition, recognition, measurement terms of definition, recognition, measurement and classification
and classification
• While liabilities in general do not have the same
range of alternative measures as assets, there are
• While the ‘historical cost’ convention underlies the still several alternative bases for measurement, both
conventional accounting system, other conventions in practice and in the accounting standards. These
have led to departures from it. Examples include: include:
 Prudence convention
 The Contracted Amount
 Accounting Period / Going Concern conventions  Estimate of Expected Future Sacrifice
 Full Disclosure / Relevant Financial Information  Present Value of the future known or expected
convention cash outflows
Interpreting the Balance Sheet Balance Sheet Deficiencies

Learning Objective: Analyse balance sheets of reporting Learning Objective: State the potential limitations of the
entities balance sheet in portraying an entity’s financial position
The balance sheet provides useful insights into the Limitations of the balance sheet in portraying
financing and investment activities of a business. In financial position are largely related to:
particular, the following aspects can be examined:
• Limitations related to the element definitions
• The liquidity of the business
• Limitations related to transaction recognisation
• The mix of assets held by the business
• The financial structure of the business • The range of alternative asset and liability
financial measures

Lecture Case Study – Week 4
(Application Exercise 3.9 Atril et.al. page 122)
You are provided with the following balance sheet equation at the start of the week
and the seven transactions for the week. Complete the table to show how each
transaction affected the accounts.
From the column totals in the table, draw up a balance sheet as at the end of the week.
Transactions for the week:

1. Purchased inventory on credit for $5,000
2. Collected $4,000 from customers
3. Sales: Cash $2,000 (Cost $1,500)
Credit $6,000 (Cost $4,500)
4. Paid creditors $7,000
5. Owner’s additional cash contribution $10,000
6. Purchased furniture for cash $6,000
7. Loan repayment of $2,000.
Cash Acc.Rec. Invent. Premises F&F = Cred. Loan Capital P&L

3,000 5,000 7,000 60,000 18,000 3,000 30,000 60,000
1
2
3
4
5
6
7

Week 4: Learning Objectives

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PowerPoint to accompany

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Nature and Purpose of a Balance

Assets Assets cont’d

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Liabilities Liabilities cont’d

Liabilities cont’d Owners’ Equity (OE, or ‘Equity)

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Note: Reserves represent ownership interests in the assets,

Effect of Trading Operations on the

Accounting equation and effects of

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Classification of Liabilities Classification of Liabilities cont’d

a) The liability is expected to be settled in the entity’s normal

Classification of Liabilities cont’d Classification of Liabilities cont’d

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Owners’ equity is normally classified in three

‘other reserves’ with sub-categories (a) retained

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

Basis of Valuation of Assets on Basis of Valuation of Liabilities

Interpreting the Balance Sheet Balance Sheet Deficiencies

Atrill, McLaney, Harvey, Jenner: Accounting 4e © 2008 Pearson Education Australia

(Application Exercise 3.9 Atril et.al. page 122)

Transactions for the week:

Cash Acc.Rec. Invent. Premises F&F = Cred. Loan Capital P&L

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