Elements of the Statement of the Financial Position

Definition

Statement of Financial Position, also known as the Balance Sheet, presents the financial
position of an entity at a given date. It is comprised of three main components: Assets,
liabilities and equity.

Statement of Financial Position helps users of financial statements to assess the financial
soundness of an entity in terms of liquidity risk, financial risk, credit risk and business risk.

Classification of Components
Statement of financial position consists of the following key elements:

Assets

An asset is something that an entity owns or controls in order to derive economic benefits from
its use. Assets must be classified in the balance sheet as current or non-current depending on
the duration over which the reporting entity expects to derive economic benefit from its use.
An asset which will deliver economic benefits to the entity over the long term is classified as
non-current whereas those assets that are expected to be realized within one year from the
reporting date are classified as current assets.

Assets are also classified in the statement of financial position on the basis of their nature:

Tangible & intangible: Non-current assets with physical substance are classified as property,
plant and equipment whereas assets without any physical substance are classified as intangible
assets. Goodwill is a type of an intangible asset.
Inventories balance includes goods that are held for sale in the ordinary course of the business.
Inventories may include raw materials, finished goods and works in progress.
Trade receivables include the amounts that are recoverable from customers upon credit sales.
Trade receivables are presented in the statement of financial position after the deduction of
allowance for bad debts.
Cash and cash equivalents include cash in hand along with any short term investments that are
readily convertible into known amounts of cash.

Liabilities

A liability is an obligation that a business owes to someone and its settlement involves the
transfer of cash or other resources. Liabilities must be classified in the statement of financial
position as current or non-current depending on the duration over which the entity intends to
settle the liability. A liability which will be settled over the long term is classified as non-current
whereas those liabilities that are expected to be settled within one year from the reporting
date are classified as current liabilities.

Liabilities are also classified in the statement of financial position on the basis of their nature:

Trade and other payables primarily include liabilities due to suppliers and contractors for credit
purchases.
Sundry payables which are too insignificant to be presented separately on the face of the
balance sheet are also classified in this category.
Short term borrowings typically include bank overdrafts and short term bank loans with a
repayment schedule of less than 12 months.
Long-term borrowings comprise of loans which are to be repaid over a period that exceeds one
year. Current portion of long-term borrowings include the installments of long term
borrowings that are due within one year of the reporting date.

Equity

Equity is what the business owes to its owners. Equity is derived by deducting total liabilities
from the total assets. It therefore represents the residual interest in the business that belongs
to the owners.

Types and Classifications of Asset

What do you mean by assets?

An asset is a resource with economic value that an individual, corporation, or country owns or
controls with the expectation that it will provide a future benefit. Assets are reported on a
company's balance sheet and are bought or created to increase a firm's value or benefit the
firm's operations.

Examples of assets include:

Cash
Receivables
Inventory
Prepaid Expenses
PPE (Property, Plant, and Equipment)
Vehicles
Furnitures & Fixtures
Intangible Assets

Classification of Assets:
1. Current Assets
Current assets are assets that can be easily converted into cash and cash equivalents (typically
within a year). Current assets are also termed liquid assets and examples of such are:

Cash
Cash equivalents
Short-term deposits
Receivables
Inventories
Office supplies

2. Fixed or Non-Current Assets

Non-current assets are assets that cannot be easily and readily converted into cash and cash
equivalents. Non-current assets are also termed fixed assets, long-term assets, or hard assets.
Examples of non-current or fixed assets include:

Land
Building
Machinery
Equipment
Patents
Trademarks

Classification of Assets: Physical Existence

If assets are classified based on their physical existence, assets are classified as either tangible
assets or intangible assets.

1. Tangible Assets
Tangible assets are assets that have a physical existence (we can touch, feel, and see them).
Examples of tangible assets include:

Land
Building
Machinery
Equipment
Cash
Office supplies
Stock
Marketable securities
2. Intangible Assets
Intangible assets are assets that do not have a physical existence. Examples of intangible assets
include:

Goodwill
Patents
Brand
Copyrights
Trademarks
Trade secrets
Permits
Corporate intellectual property

Importance of Asset Classification:

Classifying assets is important to a business. For example, understanding which assets are
current assets and which are fixed assets is important in understanding the net working capital
of a company. In the scenario of a company in a high-risk industry, understanding which assets
are tangible and intangible helps to assess its solvency and risk. Determining which assets are
operating assets and which assets are non-operating assets is important to understanding the
contribution of revenue from each asset, as well as in determining what percentage of a
company’s revenues comes from its core business activities.

Liabilities and Equity in the Statement of Financial Position.

What is liabilities in balance sheet?

Liabilities are obligations of the company; they are amounts owed to creditors for a past
transaction and they usually have the word "payable" in their account title.

Examples of liability accounts reported on a company's balance sheet include:

Notes Payable
Accounts Payable
Salaries Payable

Liabilities are financial obligations a business owes to other persons, businesses and
governments. Short-term liabilities are financial obligations that become due within a year,
while long-term liabilities are due in a year or longer. A company's total liabilities is the sum of
its short-term and long-term liabilities. Liabilities are reported on a company's balance sheet
along with its assets and owners' equity.

You should keep in mind that liabilities are financial obligations, not just debt. All debts are
financial obligations, but not all financial obligations are debts. For example, let's say you lease
a small retail space downtown and must pay rent on a monthly basis and not in arrears - in
other words, May's rent is due on May 1, not June 1. Your rent obligation is a financial
obligation, and therefore a liability, but it is not a debt because you pay for the use of the
property for the month before you use it. If you don't pay your rent on time, it becomes a debt.

What is equity in accounting?

Equity is the remaining value of an owner's interest in a company, after all liabilities have been
deducted.
You may hear of equity being referred to as
“stockholders' equity” (for corporations) or
“owner's equity” (for sole proprietorships).
Equity can be calculated as: Equity = Assets – Liabilities.

EQUITY: Drawing Account

What is meant by owner's draws?

Definition of Owner's Draws

Owner's draws are withdrawals of a sole proprietorship's cash or other assets made by the
owner for the owner's personal use. The account in which the draws are recorded is a contra
owner's capital account or contra owner's equity account since its debit balance is contrary to
the normal credit balance of the owner's equity or capital account.

The title of the account for recording R. Smith's draws from his or her business is R. Smith,
Drawing or R. Smith, Withdrawals. This account is a temporary account because its balance will
be closed at the end of each year. However, the account's debit balance is closed directly to the
owner's capital account. (The owner's draws are not reported as an expense on the company's
income statement.)

Example of Owner's Draws

Let's assume that R. Smith, the owner of a sole proprietorship, withdraws $2,000 each month
for the owner's household expenses. The company's entry to record each month's draws will
be:
A debit to R. Smith, Drawing (an owner's equity account with a debit balance)
A credit to Cash

Is the drawing account a capital account?

Definition of Drawing Account

A sole proprietorship will have a drawing account in which the owner's withdrawals or draws of
cash or other assets are recorded. The amounts of the owner's draws are recorded with a debit
to the drawing account and a credit to cash or other asset. At the end of the accounting year,
the drawing account is closed by transferring the debit balance to the owner's capital account.

The Drawing Account is a Capital Account

To answer your question, the drawing account is a capital account. It's debit balance will reduce
the owner's capital account balance and the owner's equity. The drawing account's purpose is
to report separately the owner's draws during each accounting year. Since the capital account
and owner's equity accounts are expected to have credit balances, the drawing account (having
a debit balance) is considered to be a contra account. In addition, the drawing account is a
temporary account since its balance is closed to the capital account at the end of each
accounting year.

Example of the Drawing Account

Let's assume that L. Ott begins a sole proprietorship with a cash investment of $3,000. The
journal entry will debit Cash for $3,000 and will credit L. Ott, Capital for $3,000. Later, the L. Ott
withdraws $500 from the business for her personal use. The journal entry for this transaction
will debit L. Ott, Drawing for $500 and will credit Cash for $500. After this transaction, the
business will have assets of $2,500 and will have owner's equity of $2,500.