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Week 3
            The Balance Sheet
Reference: Chapter 5
pp. 143-172,181-183




                                1
Learning Objectives
    • Explain the purpose of a Balance Sheet
    • Explain and apply the definition of assets and
      liabilities
    • Explain and apply the definition of equity
    • Prepare and interpret a Balance Sheet using the T
      format and narrative format
    • Explain and apply the measurement of assets and
      liabilities to the balance sheet
    • Discuss the limitations of the balance sheet

2
NATURE AND PURPOSE OF THE
           BALANCE SHEET
• Presents the financial position of an entity at the
  reporting date
• Lists an entity’s assets, liabilities and owner’s
  equity at reporting date (at a specific point in
  time)
• Reflects
    – the assets in which the entity has invested (its
      investing decisions), and
    – how the entity has financed the assets (its
      financing decisions)
3
NATURE AND PURPOSE OF THE
              BALANCE SHEET continued
                                                                   Balance
                               Mama Dudes Café                      date
                           Balance sheet as at 30 June
                        2010     2009                                   2010    2009
Cash at bank           12 000 30 000 Accounts payable                  37 000 55 000
Accounts receivable    12 000 14 000 Mortgage                          10 000 10 000
Inventory              30 000 28 000 Loans                             45 000 45 000
Motor vehicles         40 000 36 000 Total liabilities                 92 000 110 000
Buildings              80 000 70 000 Owner’s equity                    82 000 68 000
Total assets          174 000 178 000 Total liabilities & equity      174 000 178 000

                           Reflects duality system & accounting equation
                                     Assets = Liabilities + Equity
  4
Definition of Assets
• Essential characteristics for an asset are:
    – the resource must be controlled by the entity
    – the resource must be as a result of a past event
    – future economic benefits are expected to flow to
      the entity from the resource




5
Definition of Liabilities
• Essential characteristics for a liability are:
    – A present obligation to another entity
    – The present obligation arises as a result of past
      events
    – An outflow of resources embodying economic
      benefits is expected to flow from the entity as a
      result of settling the present obligation



6
THE DEFINITION AND NATURE OF
                EQUITY
• Equity is the residual interest in the assets
  after the liabilities are deducted
              EQUITY = ASSETS – LIABILITIES

• Equity represents the claim of owner/s on the
  firm’s assets
• Equity comprises of various items including
    – Capital contribution by owners
    – Profits retained in the entity

7
Activity 3.1
    • An Italian restaurant called Appetito has established an
      outstanding reputation. Every lunch and dinner service the
      restaurant is booked to capacity, and there is a 2 month
      waiting list for a table for non-regular customers. The
      restaurant is famous for its excellent food. The owner
      knows that the chef is critical to the restaurant’s fame and
      success. The owner believes that the chef is his biggest
      asset, and wants to record the chef as an asset on the
      business balance sheet. The owner asks for your opinion on
      this.
    • Can the chef be recorded as an asset on the balance sheet?
      Discuss

8
FORMAT AND PRESENTATION OF THE
             BALANCE SHEET
• Two main formats
     – T-format
        • Assets on left-hand side and liabilities on right-hand side
        • Often used for smaller entities
     – Narrative format
        • Assets, liabilities and equity presented down the page, net
          assets is also shown
• Comparative information allows users to see
  how firm’s financial position has changed
  between the previous and current periods
  (shown in example on slide 10)
 9
FORMAT AND PRESENTATION OF THE
          BALANCE SHEET (T-format)

                               Mama Dudes Café
                           Balance sheet as at 30 June
                        2010     2009                                2010    2009
Cash at bank           12 000 30 000 Accounts payable               37 000 55 000
Accounts receivable    12 000 14 000 Mortgage                       10 000 10 000
Inventory              30 000 28 000 Loans                          45 000 45 000
Motor vehicles         40 000 36 000 Total liabilities              92 000 110 000
Buildings              80 000 70 000 Owner’s equity                 82 000 68 000
Total assets          174 000 178 000 Total liabilities & equity   174 000 178 000



  10
FORMAT AND PRESENTATION OF THE
      BALANCE SHEET (Narrative format)




11
CLASSIFICATION, PRESENTATION AND DISCLOSURE OF
             ELEMENTS ON THE BALANCE SHEET


• Accounting standards (rules) exist that
  prescribe the presentation, classification and
  disclosure requirements for assets, liabilities
  and equity on the balance sheet
• Assets and liabilities are generally classified,
  which means separated into Current and Non-
  Current


12
Current and non-current
           assets and liabilities
• Distinction between current and non-current
  classification is based on timing
• If the economic benefits (of asset) or outflow of
  resources (for liability) are expected to be
  realised in the next reporting period (next 12
  months), the asset or liability is categorised as
  current
• If economic benefits (of asset) or outflow of
  resources (of liability) are expected beyond next
  the reporting period, the classification is non-
  current

13
Classification in the Balance Sheet
Current Assets –assets that are cash, we will
be used or converted to cash within 12
months e.g. cash accounts receivable,
inventory, supplies, prepayments
Non-current Assets – assets that are not
current assets (i.e. more than 12 months). e.g.
building, land, equipment, motor vehicles
Classification in the Balance Sheet
Current Liabilities – the debt is expected to be
settled within 12 months. e.g. Accounts
payable (creditors), wages payable, bank
overdraft, unearned revenue
Non-current Liability – any liability that is not
a current liability. e.g. 3 year bank loan
payable, mortgage payable
Current and non-current
           assets and liabilities continued
• On the balance sheet, an entity will usually
  show total amounts for
     – Current asset
     – Non-current assets
     – Current liabilities
     – Non-current liabilities




16
Classification, presentation and disclosure of
                 assets, liabilities and equity

• Assets are classified according to their nature
  or function
• Classifications can reflect
     – Liquidity
     – Marketability
     – Physical characteristics
     – Expected timing of future economic benefits
     – Purpose

17
Classification, presentation and disclosure of
           assets, liabilities and equity continued

 Assets – Classes include:
• Cash and cash equivalents      • Financial assets
• Trade receivables              • Property, plant and
• Inventories                      equipment
• Non-current assets held for    • Deferred tax assets
  sale                           • Agricultural assets
• Investments accounted for      • Intangible assets
  using equity method            • Goodwill


18
JB Hi-Fi Ltd




19
Classification, presentation and disclosure of assets,
                  liabilities and equity continued

• Liabilities and equity are classified according
  to their nature
• Classifications may be based on:
      – Liquidity
      – Level of security of guarantee
      – Expected timing of the future sacrifice
      – Source
      – Conditions attached to the liabilities

20
Classification, presentation and disclosure of assets,
                  liabilities and equity continued

 Liabilities – Classes include:
     •   Trade and other payables
     •   Borrowings
     •   Tax liabilities
     •   Provisions
     •   Financial liabilities
     •   Secured debts


21
JB Hi-Fi Ltd




22
Classification, presentation and disclosure of
            assets, liabilities and equity continued

 Equity – Classes include (for a company):

• Share capital
     – Paid-up share capital, contributed capital
• Retained earnings
• Reserves (e.g. Asset Revaluation Reserve)




23
JB Hi-Fi Ltd




24
Activity 3.2
     • Classify the following items as current or non-current
       assets, current or non-current liabilities or equity
        – Cash at Bank, Loan Payable (due in 5 years), Share Capital,
          Accounts Receivable, Tax Payable, Inventory, Retained
          Earnings, Land, Equipment




25
MEASUREMENT OF ASSETS AND
              LIABILITIES
     Different methods of valuation are used for
     different assets and liabilities on the balance
     sheet.
     Following are some examples of different
     values that are shown for items on the
     balance sheet.

     The dollar value assigned to assets and
     liabilities is called their “carrying amounts” or
     “book values”.

26
MEASUREMENT OF ASSETS AND
          LIABILITIES continued
• Assets and liabilities initially recorded at their
  historical cost (original cost).
• Non-current assets can continue to be recorded
  at historical cost, or can be revalued to fair value
  (market value).
• Inventory must be valued at the lower of its cost
  price and estimated selling price.
• Accounts receivable must be shown at the
  amount that is estimated to be collectable.

27
Measuring non-current assets
                      continued

• All non-current assets with limited useful lives
  must be depreciated
• Land is not depreciated
• Depreciation is the allocation of the cost of the
  asset to expense over its useful life
• On balance sheet, depreciable assets are carried
  at their cost (or fair value) less accumulated
  depreciation (accumulated depreciation is the
  sum of all depreciation expense for the asset)
28
Activity 3.3
     • The following is an extract from the balance sheet:
          Balance Sheet (extract)               $000    $000
          Land at independent valuation                 5,860
          Buildings at fair valuation           3,790
          Less Accumulated Depreciation         1,270   2,520
          Plant and Equipment at cost           9,460
          Less Accumulated Depreciation         5,510   3,950
          Total Property, Plant and Equipment           12,330

     • As a user of the balance sheet, what does the $12,330
       total property, plant and equipment asset value mean
       to you?

29
Activity 3.4
     • From the following account balances of Daisy Pty Ltd as at
       30 September 2011, prepare a balance sheet in both the T-
       format and the narrative format:
                   Accounts receivable (net)    25,000
                   Cash at Bank                 $50,000
                   Equipment                    6,000
                   Inventory                    20,000
                   Land                         25,000
                   Loan Payable (due in 2020)   5,000
                   Retained Earnings            96,000
                   Share Capital                20,000
                   Tax Payable                  5,000

30
POTENTIAL LIMITATIONS OF THE
            BALANCE SHEET
1. Shows asset, liability and equity values at a
  particular point in time and may not be
  representative of other points in time
2. The entity’s value is not reflected due to:
     – Items that generate future benefits or involve
       future sacrifices and cannot be measured reliably
       in dollars are not shown
     – The historical nature (or combinations of cost and
       fair values) of the balance sheet
31
POTENTIAL LIMITATIONS OF THE
          BALANCE SHEET continued
3. Preparing a balance sheet involves:
     – management choices
     – judgements
     – estimations




32
Summary
• The balance sheet reports an entity’s financial
  position at a point in time
• A balance sheet may be presented in a
  narrative or T-format
• Asset and liabilities are classified into current
  and non-current to provide for useful
  information for decision-making
• Different ways are used to measure different
  assets and liabilities on the balance sheet
33
Homework Questions
• The following homework questions should be
  completed from the textbook before class in week
  4:

     Chapter 5
     Comprehension Questions 5.2, 5.3, 5.7 page 187
     Exercises 5.17, 5.18, 5.24 parts a to d, 5.11
        pages 192-193
     Problem 5.34 page 195



34

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Acc101 week 3

  • 1. Week 3 The Balance Sheet Reference: Chapter 5 pp. 143-172,181-183 1
  • 2. Learning Objectives • Explain the purpose of a Balance Sheet • Explain and apply the definition of assets and liabilities • Explain and apply the definition of equity • Prepare and interpret a Balance Sheet using the T format and narrative format • Explain and apply the measurement of assets and liabilities to the balance sheet • Discuss the limitations of the balance sheet 2
  • 3. NATURE AND PURPOSE OF THE BALANCE SHEET • Presents the financial position of an entity at the reporting date • Lists an entity’s assets, liabilities and owner’s equity at reporting date (at a specific point in time) • Reflects – the assets in which the entity has invested (its investing decisions), and – how the entity has financed the assets (its financing decisions) 3
  • 4. NATURE AND PURPOSE OF THE BALANCE SHEET continued Balance Mama Dudes Café date Balance sheet as at 30 June 2010 2009 2010 2009 Cash at bank 12 000 30 000 Accounts payable 37 000 55 000 Accounts receivable 12 000 14 000 Mortgage 10 000 10 000 Inventory 30 000 28 000 Loans 45 000 45 000 Motor vehicles 40 000 36 000 Total liabilities 92 000 110 000 Buildings 80 000 70 000 Owner’s equity 82 000 68 000 Total assets 174 000 178 000 Total liabilities & equity 174 000 178 000 Reflects duality system & accounting equation Assets = Liabilities + Equity 4
  • 5. Definition of Assets • Essential characteristics for an asset are: – the resource must be controlled by the entity – the resource must be as a result of a past event – future economic benefits are expected to flow to the entity from the resource 5
  • 6. Definition of Liabilities • Essential characteristics for a liability are: – A present obligation to another entity – The present obligation arises as a result of past events – An outflow of resources embodying economic benefits is expected to flow from the entity as a result of settling the present obligation 6
  • 7. THE DEFINITION AND NATURE OF EQUITY • Equity is the residual interest in the assets after the liabilities are deducted EQUITY = ASSETS – LIABILITIES • Equity represents the claim of owner/s on the firm’s assets • Equity comprises of various items including – Capital contribution by owners – Profits retained in the entity 7
  • 8. Activity 3.1 • An Italian restaurant called Appetito has established an outstanding reputation. Every lunch and dinner service the restaurant is booked to capacity, and there is a 2 month waiting list for a table for non-regular customers. The restaurant is famous for its excellent food. The owner knows that the chef is critical to the restaurant’s fame and success. The owner believes that the chef is his biggest asset, and wants to record the chef as an asset on the business balance sheet. The owner asks for your opinion on this. • Can the chef be recorded as an asset on the balance sheet? Discuss 8
  • 9. FORMAT AND PRESENTATION OF THE BALANCE SHEET • Two main formats – T-format • Assets on left-hand side and liabilities on right-hand side • Often used for smaller entities – Narrative format • Assets, liabilities and equity presented down the page, net assets is also shown • Comparative information allows users to see how firm’s financial position has changed between the previous and current periods (shown in example on slide 10) 9
  • 10. FORMAT AND PRESENTATION OF THE BALANCE SHEET (T-format) Mama Dudes Café Balance sheet as at 30 June 2010 2009 2010 2009 Cash at bank 12 000 30 000 Accounts payable 37 000 55 000 Accounts receivable 12 000 14 000 Mortgage 10 000 10 000 Inventory 30 000 28 000 Loans 45 000 45 000 Motor vehicles 40 000 36 000 Total liabilities 92 000 110 000 Buildings 80 000 70 000 Owner’s equity 82 000 68 000 Total assets 174 000 178 000 Total liabilities & equity 174 000 178 000 10
  • 11. FORMAT AND PRESENTATION OF THE BALANCE SHEET (Narrative format) 11
  • 12. CLASSIFICATION, PRESENTATION AND DISCLOSURE OF ELEMENTS ON THE BALANCE SHEET • Accounting standards (rules) exist that prescribe the presentation, classification and disclosure requirements for assets, liabilities and equity on the balance sheet • Assets and liabilities are generally classified, which means separated into Current and Non- Current 12
  • 13. Current and non-current assets and liabilities • Distinction between current and non-current classification is based on timing • If the economic benefits (of asset) or outflow of resources (for liability) are expected to be realised in the next reporting period (next 12 months), the asset or liability is categorised as current • If economic benefits (of asset) or outflow of resources (of liability) are expected beyond next the reporting period, the classification is non- current 13
  • 14. Classification in the Balance Sheet Current Assets –assets that are cash, we will be used or converted to cash within 12 months e.g. cash accounts receivable, inventory, supplies, prepayments Non-current Assets – assets that are not current assets (i.e. more than 12 months). e.g. building, land, equipment, motor vehicles
  • 15. Classification in the Balance Sheet Current Liabilities – the debt is expected to be settled within 12 months. e.g. Accounts payable (creditors), wages payable, bank overdraft, unearned revenue Non-current Liability – any liability that is not a current liability. e.g. 3 year bank loan payable, mortgage payable
  • 16. Current and non-current assets and liabilities continued • On the balance sheet, an entity will usually show total amounts for – Current asset – Non-current assets – Current liabilities – Non-current liabilities 16
  • 17. Classification, presentation and disclosure of assets, liabilities and equity • Assets are classified according to their nature or function • Classifications can reflect – Liquidity – Marketability – Physical characteristics – Expected timing of future economic benefits – Purpose 17
  • 18. Classification, presentation and disclosure of assets, liabilities and equity continued Assets – Classes include: • Cash and cash equivalents • Financial assets • Trade receivables • Property, plant and • Inventories equipment • Non-current assets held for • Deferred tax assets sale • Agricultural assets • Investments accounted for • Intangible assets using equity method • Goodwill 18
  • 20. Classification, presentation and disclosure of assets, liabilities and equity continued • Liabilities and equity are classified according to their nature • Classifications may be based on: – Liquidity – Level of security of guarantee – Expected timing of the future sacrifice – Source – Conditions attached to the liabilities 20
  • 21. Classification, presentation and disclosure of assets, liabilities and equity continued Liabilities – Classes include: • Trade and other payables • Borrowings • Tax liabilities • Provisions • Financial liabilities • Secured debts 21
  • 23. Classification, presentation and disclosure of assets, liabilities and equity continued Equity – Classes include (for a company): • Share capital – Paid-up share capital, contributed capital • Retained earnings • Reserves (e.g. Asset Revaluation Reserve) 23
  • 25. Activity 3.2 • Classify the following items as current or non-current assets, current or non-current liabilities or equity – Cash at Bank, Loan Payable (due in 5 years), Share Capital, Accounts Receivable, Tax Payable, Inventory, Retained Earnings, Land, Equipment 25
  • 26. MEASUREMENT OF ASSETS AND LIABILITIES Different methods of valuation are used for different assets and liabilities on the balance sheet. Following are some examples of different values that are shown for items on the balance sheet. The dollar value assigned to assets and liabilities is called their “carrying amounts” or “book values”. 26
  • 27. MEASUREMENT OF ASSETS AND LIABILITIES continued • Assets and liabilities initially recorded at their historical cost (original cost). • Non-current assets can continue to be recorded at historical cost, or can be revalued to fair value (market value). • Inventory must be valued at the lower of its cost price and estimated selling price. • Accounts receivable must be shown at the amount that is estimated to be collectable. 27
  • 28. Measuring non-current assets continued • All non-current assets with limited useful lives must be depreciated • Land is not depreciated • Depreciation is the allocation of the cost of the asset to expense over its useful life • On balance sheet, depreciable assets are carried at their cost (or fair value) less accumulated depreciation (accumulated depreciation is the sum of all depreciation expense for the asset) 28
  • 29. Activity 3.3 • The following is an extract from the balance sheet: Balance Sheet (extract) $000 $000 Land at independent valuation 5,860 Buildings at fair valuation 3,790 Less Accumulated Depreciation 1,270 2,520 Plant and Equipment at cost 9,460 Less Accumulated Depreciation 5,510 3,950 Total Property, Plant and Equipment 12,330 • As a user of the balance sheet, what does the $12,330 total property, plant and equipment asset value mean to you? 29
  • 30. Activity 3.4 • From the following account balances of Daisy Pty Ltd as at 30 September 2011, prepare a balance sheet in both the T- format and the narrative format: Accounts receivable (net) 25,000 Cash at Bank $50,000 Equipment 6,000 Inventory 20,000 Land 25,000 Loan Payable (due in 2020) 5,000 Retained Earnings 96,000 Share Capital 20,000 Tax Payable 5,000 30
  • 31. POTENTIAL LIMITATIONS OF THE BALANCE SHEET 1. Shows asset, liability and equity values at a particular point in time and may not be representative of other points in time 2. The entity’s value is not reflected due to: – Items that generate future benefits or involve future sacrifices and cannot be measured reliably in dollars are not shown – The historical nature (or combinations of cost and fair values) of the balance sheet 31
  • 32. POTENTIAL LIMITATIONS OF THE BALANCE SHEET continued 3. Preparing a balance sheet involves: – management choices – judgements – estimations 32
  • 33. Summary • The balance sheet reports an entity’s financial position at a point in time • A balance sheet may be presented in a narrative or T-format • Asset and liabilities are classified into current and non-current to provide for useful information for decision-making • Different ways are used to measure different assets and liabilities on the balance sheet 33
  • 34. Homework Questions • The following homework questions should be completed from the textbook before class in week 4: Chapter 5 Comprehension Questions 5.2, 5.3, 5.7 page 187 Exercises 5.17, 5.18, 5.24 parts a to d, 5.11 pages 192-193 Problem 5.34 page 195 34