Week 2 ACCY111 Lecture

Statement of Financial Position (Balance Sheet)

Balance Sheet:

• Reports financial position of an entity at a specific point in time

• Shows assets, liabilities and equity of the entity.
• Measure of liquidity and solvency.
• Represents the accounting equation:
Assets = Liabilities + Equity
• Conceptual framework of accounting: Accounting standards we need to prepare a
financial statement.
• Assets: A present economic resource controlled by the entity as a result of past events.
• Economic Resource: A right that has the potential to produce economic benefits.
o Needs to be controlled by the entity

Current assets:

• Assets expected to be converted to cash or used in the business within the year
• Listed in order of liquidity
• Examples:
o Cash
o Accounts Receivable – Credit customers
o Inventory/Stock – The product being sold to the public.
o Supplies
o Inventory / stock
• Liquidity – how quickly a business can covert assets into cash

Non-Current Assets:

• Liquidity is still in the picture as a business can work out which non-current assets is the
quickest and easiest to sell to convert into cash
• Property, plant, and equipment
• Motor Vehicle
• Land
• Buildings
• Machinery and equipment
• Furniture and fixtures

Liabilities in the current Conceptual Framework:

• Liability is a present obligation of the entity to transfer an economic resource as a result

of past events.

Current Liabilities:

• Debts expected to be paid in one year

o Accounts payable (creditors) These are the suppliers, that a business buys from
on credit.
o Wages payable
 o Short term loans payable – interest that the business has to pay from banks.
Includes taxes to the Australian Government (ATO).
o Interest payable
o Taxes payable

Non-Current Liabilities:

• Debts expected to be paid after one year

o Mortgage payable
o Long-term loans
o Deferred income taxes
o Superannuation

Equity according to the CFW

• The Conceptual Framework defines equity as ‘The residual interest of the owner/s in the
assets (less liabilities) of the entity:

• Also called Capital or Accumulated Surplus/Funds

• Whatever is left over from the assets once the liabilities have been taken away is the
equity.
• Also called Capital
• Government / Non-for-profit constitutions also call equity, Accumulated / Surplus /
Fund.
Balance Sheet (account format):

• Balance sheet can also be known as statement of financial position

• Account format presents the accounting equation as A = L + E
1. Name of Business
2. Name of statement
3. Date
• Assets on the left. Order for assets:
1. Cash
2. Accounts receivable – cause it’s the next easiest to obtain because there is a legal
agreement to receive the money.
3. Land / Building

Balance Sheet (Narrative Format):

• Presents is through the equation A – L = Equity

• Structure:
1. Assets – in order of Liquidity
2. Total Assets
3. Liabilities
4. Total Liabilities
• Man diff is that the narrative format shows the net assets.
• Net assets = Total Assets – Total Liabilities
• Net assets = Total Equity
• Most business use a narrative format
Summary:

• Presents the current balances of the recorded assets, liabilities, and equity of an
organization.
• Narrative Format: A-L=E
• Account Format: A=L+E

Statement of Financial Performance (Income Statement)

Income statements (statement of financial performance)

• Income statement: Reports financial performance over a specific time period.

o Sometimes called Profit or Loss statement or Operating Statement.
o Government / NFP entity call it an operating statement
• Income and expense:
o Income (selling stock) - expenses (e.g. wages) = Profit (Visa versa for loss)

Income in the current Conceptual Framework:

• Increases in wealth by owners through a sale or product or performance in a particular

service
Expenses in the current conceptual framework:

• Expenses: Decreases in assets, or increase in liabilities, that result in decreases in equity,

other than those relating to distributions to holders of equity claims.
o Decrease in the wealth of owners.

Structure of the income Statement

1. Heading (name of the entity that is being reported)

2. Name of the statement (e.g. statement of financial performance, income statement)
3. Date – very important as it allows us to understand the time it took the business to generate
the cash flow they did in the time they did.
4. Income on the top (e.g. accounting income -> service income)
5. Expenses underneath income (no rule on how to list the expenses – any order we like)
6. Profit (income – Expense)

Statement of Changes in Equity

• Explains the changes in Equity and Capital during a period of time (e.g. year).
• Opening capital + Profit (or subtract loss) – drawings = Closing Capital
o Drawings is money withdrawn from the business for personal use - normally
cash
• Increase in profit will increase total equity
• Increase in owner capital / contribution will increase closing capital

Structure of statement of changes in Equity

1. Name of business
2. Name of statement
3. Date
4. Beginning Capital (e.g. if sole trader, then it will be there name then capital after, e.g. Minh
Vu, capital)
5. Add profit for the year
6. Minus any drawings
7. Perform equal to calculate capital at the bottom of the page
Financial Statements Relationships:
The Effects of Transactions on the Accounting Equation

Accounting Equation

• Assets = Liabilities + Equity

• OE’s – The owners claim after all liabilities have been paid from assets.
• Double – entry accounting
• Every transaction (paying salaries, equipment purchase) affects at least two components of
the equation.
• After each transaction is recorded the accounting equation must remain balanced (Assets =
liabilities + OE)

Example Question

• Joe Surfer opened Hawaii Surfboards on 1 June 2019. Consider the effects of following
transactions on accounting equation:
1. Joe deposits $53 000 of personal savings in a business bank account.
▪ Capital and Asset invested
2. Joe purchased in cash surfboards for $32000 and paddle boards for $6000.

▪ Minus 38K because that’s his total expenses

▪ Joe gains them back in assets as they will make him money
▪ Assets still equals 53,000 (15K + 6K + 32K)
▪ The 3 accounts are affected are cash at bank, paddle board, surfboard
3. Joe purchased surfing supplies for $2500 on credit.

▪ Credits = accounts payable

▪ New asset in surfing supplies ($2,500)
▪ Cause it’s on credit (accounts payable), the $2,500 is also a liability.
▪ Balanced equation as both sides are equal
Summary

• Transactions result in changes in assets, liabilities and owners’ equity

• Elements of the accounting equation change with each transaction, but equality of
accounting equation remains unchanged
• The accounting equation always balances – Foundation of the idea of double-entry
accounting

Underlying assumptions of financial statements

1. Accounting Entity Assumption

o Identifies clearly the boundaries of the entity being accounted for
o Personal transactions (owners) must be separate from the transactions of the
entity. (owners assets / liabilities must be separate from business)
o This is because each entity controls its assets and incurs its liabilities
2. Accrual Basis Assumption
o Any business event that impacts the account balance on the financial statement
o Effects of transactions are recognised when they occur, not when the cash is
received / paid.
o E.g. Revenues should be recognised when transactions happened not when cash is
received. Same as expense being recognised when incurred, not when paid.
3. Going Concern Assumption
o Assume an entity will continue to operate in the future unless there is evidence to
contrary.
4. Period Assumption
o Life of an entity can be “broken up” into equal time intervals
o Financial statements should cover a consistent period of time
o Profit is determined for particular periods of time in order to be comparable
o This division of the life of the entity into equal time intervals is known as the
reporting period.

Qualitative Characteristics of Financial Information

• IASB’s Conceptual Framework’s six main qualitive characteristics in order to be the subject
matter of general-purpose financial reports:
o Relevance
▪ Financial information must have a quality that makes a difference in a
decision of an economic nature made by users.
▪ Information should be relevant for our decision (economic decisions)
o Faithful representation
▪ Information must be complete, without bias and free from material error.
▪ Information represented should be a representation of the real-world
phenomena
o Comparability
▪ Enables users to identify and understand similarities in, and differences
among, items.
▪ E.g. Comparing balance sheet items from one entity with previous entries
from the past number of years.
o Verifiability
▪ It means that different knowledgeable and independent observers could
reach consensus, although not necessarily complete agreement, that a
particular piece of information is a faithful representation of the economic
phenomena.
▪ Different, independent observers can reach consensus that information
faithfully represents what it claims to.
o Timeless and understandability
▪ Timeless: Having information available to decision makers in time to be
capable of influencing their decisions.
▪ Understandability: Expect / assume a reasonable knowledge of business and
economic activity and financial accounting.