PowerPoint to accompany

ATRILL
MCLANEY
HARVEY
JENNER

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2005 Pearson Education Australia

Chapter 3

Measuring and
Reporting Financial
Position

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2005 Pearson Education Australia

Learning Objectives
Explain the nature & purpose of the balance
sheet
Demonstrate an understanding of assets in
terms of definition, recognition, measurement
and classification
Demonstrate an understanding of liabilities in
terms of definition, recognition, measurement
and classification
Discuss the nature and classification of owners
equity
Explain the basic accounting equation
Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 3
Learning Objectives Contd

Contrast the alternative balance sheets formats

Discuss the main factors that influence the
content and values within a balance sheet
Prepare a simple balance sheet
Analyse balance sheets of reporting entities
Discuss the potential limitations of the balance
sheet in portraying the financial position of an
entity

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 4

Financial statement
relationships

Balance sheet Balance sheet Balance sheet

P&L account P&L account

Cash flow statement Cash flow statement

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 5

Nature and Purpose of a
Balance Sheet

Purpose = set out the financial position of a

business at a particular point in time

As from January 2009 an accounting

standard recommendation is that the
balance sheet should be referred to as a
statement of financial position

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 6

Nature and purpose of a
balance sheet

Three key components:

1. Assets

2. Liabilities

3. Owners Equity

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 7

1. Assets

Definition

a resource controlled by an entity as a

result of past events and from which
economic benefits are expected to
flow to the entity.

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 8

1. Assets

Recognition:

Expected future economic benefit

Control of benefit
Past transaction or event
Reliable measurement in monetary
terms
Note that these conditions limit the kind of items that may be referred to
as assets in financial reports

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 9

1. Assets
Classification of Assets

Current Assets:
Include cash or other assets which are expected to be
consumed over short period of time (less than 1 year)
Held as part of the day to day trading activities of the
business
most liquid (quickly converted to cash)

Non-current Assets:
consumed over longer period of time (more than 1 year)
used to generate revenue
Illiquid (cannot be easily converted to cash)

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 10

1. Assets

Examples of Assets
Freehold premises
Machinery and equipment
Furniture, fixtures and fittings
Patents and trade marks
Debtors (also known as accounts receivable)
Investments
Cash

Assets may be either tangible or intangible

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 11
 Claims Against the Assets

Two types of claims against the assets of an entity:

External claims - known as liabilities

Internal claims - labelled owners equity, equity,
or capital

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 12

2. Liabilities

Definition

a present obligation of the entity arising

from past events, the settlement of
which is expected to result in an
outflow from the entity of resources
embodying economic benefits.

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 13

2. Liabilities

Recognition

Probability of occurrence obligation

Past event
Reliability of measurement
Outflow of resources embodying
economic benefits

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 14

2. Liabilities

Classification
Current Liabilities
to be repaid in a short period of time (usually <1
year)

Non-current Liabilities
repaid over longer period of time

NB: Any long term loan that is now due in less than one year
becomes a Current Liability

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 15

2. Liabilities

Examples
Creditors
Staff entitlements
Loans and overdrafts
Warranty provisions

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 16

3. Owners equity

Definition
The claim of the owner(s) against the
business

AASB Framework defines equity as

the residual interest in the assets of
the entity after deducting all its
liabilities.

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 17

3. Owners equity

Characteristics

A clear distinction is made in accounting

terms between the business and its owner
regardless of size

This occurs irrespective of whether the

business is a separate legal entity or not.

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 18

3. Owners equity

Characteristics
Reserves special purpose owners equity
accounts
Usually identified in order to make a
provision of retained profits
May also include asset revaluation reserves.

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 19

3. Owners equity

Classification
Owners equity contributed
Reserves:
Retained profit
Other reserves

Drawings (for sole proprietorship and

partnership only)

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The accounting equation

Assets Liabilities = Owners Equity

OR
Assets = Liabilities + Owners Equity

This equation will always hold true, as total claims (against the
assets) are always the same as total assets, ensuring that the
balance sheet always balances

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 21

 Formats for Balance Sheets:
Horizontal or T
RMIT University Vietnam
Statement of Financial Position
As at Dec 31, 2010

Current Assets Current Liabilities

Cash at bank XXXX Trade Creditor XXXX
Trade Debtor XXXX Short term loans XXXX
Inventory XXXX Total current liabilities XXXX
Total current assets XXXX
Non-current Liabilities
Long term Loan XXXX
Total non-current liabilities XXXX

Non-current Assets
Computers XXXX Owners Equity
Motor vehicle XXXX Capital XXXX
Plant and equipment XXXX Retained Earnings/profits XXXX
Less Drawing (XXXX)

Total non-current assets XXXX Total Owners Equity XXXX

Total assets XXXX Total liabilities + Owners Equity XXXX

Atrill, McLaney, Harvey, Jenner: Accounting 3e 2006 Pearson Education Australia 22

Formats for Balance Sheets:
Vertical or Narrative
RMIT University Vietnam
Statement of Financial Position
As on Dec 31, 2010
Current Assets
Cash at bank xxxx
Trade Debtor xxxx
Inventory xxxx
Total current assets xxxxx
Non-current Assets
Computers xxxx
Motor vehicle xxxx
Plant and equipement xxxx
Total non-current assets xxxxx
Total Assets xxxxx

Current liabilities
Trade creditor xxxx
Short-term loan xxxx
Total current liabilities xxxxx
Non-current liabilities
Long-term loan xxxx
Total non-current liabilities xxxxx
Total liabilities xxxxx
Net assets xxxxx
Owners equity
Capital xxxx
Retained Earnings xxxx
Less Drawing (xxxx)
Total Owners Equity xxxxx
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The 5 Basic Accounting
Elements

Assets
Liabilities
Owners equity
Income
Expenses

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Effect of Trading Operations on the Balance
Sheet: Transaction Analysis & the Basic
Accounting Equation

Every transaction has at least 2 effects on the

accounting equation
Transaction analysis
How assets, liabilities, owners equity are affected
Specific asset, liability, owners equity item affected
Reports show details of each as well as totals

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Example: Sole proprietor contributes
$100,000 to commence a business
Accounting element/s Specific owners equity
affected by this item/account affected by
transaction (OE) this transaction (capital)

Owners equity (capital) by $100,000

Assets (cash at bank) by $100,000

Specific asset
Accounting element/s
item/account affected
affected by this
by this transaction
transaction (A)
(cash at bank)

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Factors influencing content
and values in a balance sheet

1. Conventional accounting practice

Doctrines, principles, assumptions and accepted
ideas on which accounting rules, records and reports
were or are based
Collectively known as GAAP

2. Conceptual framework
Statements of Accounting Concepts (SACs)

3. Accounting standards
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Basis of valuation of assets in
the balance sheet

Historical cost convention underlies

the valuation of assets
Prudence convention
Going concern convention
Full disclosure

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Basis of valuation of liabilities
in the balance sheet

Contracted amount
Estimate of expected future sacrifice
Present value of future known or
expected cash flows

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Interpreting the Balance Sheet

The balance sheet provides useful insights

into the financing and investment activities
of a business, in particular:
The liquidity of the business
The mix of assets held by the business
The financial structure of the business

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Limitations of balance sheet

Element definitions
Transaction recognition
Non-financial measures

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