CHAPTER 5 Balance Sheet Financial Reporting obligations

Incorporated entities (entities structured as companies) generally lodge FS with a relevant regulatory body (ASIC) Legislative obligations exist for some public sector entities e.g. hospitals, local councils etc. Partnerships + sole traders no legal requirements

General purpose & special purpose FS

If an entity has indicative factors that suggest it is a reporting entity, it should prepare a GPFSs. If an entity is assessed as a non-reporting entity, it can prepare special purpose FS. > Reporting entity = with users who rely on info in GPFSs to meet their info needs.

Nature & purpose of the Balance sheet

To generate profits/provide services, entities need to invest in productive assets. Value creation can occur if the assets in which an entity invests appreciate in value. >
Investing decision = decisions involving (a) the acquisition & sale of investments and

productive non-current assets using cash, and (b) lending money & collecting on those loans. > External claims (lenders) on the entitys assets are termed liabilities. Internal claims (owners) are referred to as equity. >
Financing decisions = decisions involving the mix of debt & equity financing chosen by the

entity. The balance sheet is usually prepared at the end of the reporting period but can be prepared @ any date. Analysing a BS enable users to make a preliminary assessment as to the financial position of the entity. E.g.: > CCS commenced the business with an investment of $50,000 & a loan of $30,000. As at 20/8/13, CCS has invested in some office furniture & equipment only. Cash in bank still high. CCS is unlikely to face liquidity issues in the short term. > Liquidity = ability of an entity to meet its short-term financial commitments

Accounting policy choices, estimates & judgements

There are numerous accounting rules that permit choices. E.g.: > > > Alternative methods of costing inventory The valuation of property, plant & equipment subsequent to acquisition The treatment of development expenditures as an asset or as an expense

CHAPTER 5 Balance Sheet The definition & recognition of assets Liability recognition Asset = a resources controlled by the entity as a result of past events and from which future eco benefits are

expected to flow to the entity.

Control

o o

Legal ownership = control, however it is not a prerequisite Control refers to the capacity of the entity to benefit from the asset in the pursuit of its objectives & to deny or regulate the access of others to the benefit. E.g. An entity that leases an asset required for its manufacturing process. The lessee (entity) pays the lessor (owner) a monthly rental. The lease contract specifies that the lease can be cancelled by the lessor with 1 months notice. In this scenario, the entity is able to use the asset but it doesnt control the asset, given that the lessor can cancel the contract. It is the lessor who controls access to the asset.

Past event a result of an exchange transaction, non-reciprocal transfers or discoveries. Future eco benefits service potential

Items must provide benefits to the entity. It can take the form of having G&S desired by customers available for sale and of being able to satisfy human wants.

Future benefits dont necessarily have to involve cash.

Asset recognition

Items have to be measured in monetary terms. If items cannot be assigned a monetary value, they cannot appear on BS To be recognised as an asset on the BS, the future eco benefits must be probable & capable of being measured reliably.

CHAPTER 5 Balance Sheet The definition & recognition of liabilities Liability definition Liability = 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 eco benefits.

Present obligation can be a legal contractual obligation, can arise as a result of a duty to do what

is fair, just and right or it can arise if a particular sets of facts creates valid expectations in other parties that the entity will satisfy the obligation. o If an entity has no realistic alternative to settling to obligation, the obligation = present obligation. o E.g. If an entity has entered into a binding non-cancellable contractual arrangement to purchase specialize equipment, and subsequently cancels the order, a liability will exist.
Past event Outflow of resources embodying eco benefits

E.g. accounts payable involve future sacrifices of eco benefits, future sacrifice doesnt have to be a cash sacrifice

Liability recognition To be recognised, the outflow of resources embodying future benefits must be probable & capable of being measured reliably.
Contingent (existence of an asset or liability arising from a past even that may be confirmed only by

uncertain future events not controllable by the entity) is used to describe A & L. E.g. an entity may be embroiled in a court case, resulting in a contingency being disclosed in the entitys notes to the accounts.

CHAPTER 5 Balance Sheet The definition & nature of equity Equity = the residual interest in the assets of the entity after all its liabilities have been deducted.

Cannot be defined independently of assets & liabilities Comprises various items, including capital contributed by owners (share capital/contributed capital) and profits retained in the entity (retained earnings)

Format & presentation of balance sheet

T-format used by smaller entities

Assets on left side, liabilities & equity on right side

Narrative format larger entities

Presents A, L & E down the page

Comparative information presenting the balance sheet for the prev. reporting period + current

reporting period. Allows users to see how the entitys financial position has changed. Parent entity an entity that controls another entity. A controlled entity = subsidiary entity. Having more than of the voting power in another entity is normally regarded as being able to control that entity. BUT even if they held less, an entity may still be regarded as controlling another entity if it has powers to govern the financial & operating policies of the entity. E.g. having a # of directors on the board of another entity. Group (Economic entity) = parent entity + all subsidiaries. When preparing consolidated financial statements, intercompany sales and purchases (e.g. company A selling goods to company B) are eliminated.

CHAPTER 5 Balance Sheet Presentation & disclosure of elements on BS

Small entities w/ no public accountability are not required to comply with accounting standards. This means that they are unconstrained in the preparation of their FS. Small business operations hasnt raised equity / debt capital from the public & doesnt have investors & shareholders who depend on FS to monitor & assess their investment decisions. Some entities w/ no public accountability voluntarily adopt presentation & disclosure practices required by accounting standards.

Current & non-current A & L

The distinction b/w current assets & non-current assets is based on the timing of the future eco benefits & the timing of the expected future sacrifices.
Current assets Cash and other assets that are expected to be converted to cash or used in the

entity within 1 year or one operating cycle, whichever is longer

Non-current assets assets that are not expected to be consumed or sold within one year/one

operating cycle.
Current liabilities obligations that can reasonably be expected to be paid within Non-current liabilities expected to be paid after

Grouping as current/non-current is useful when assessing entitys liquidity, the likelihood the entity will be able to pay its debts as they fall due. Classifying examples: o An entity has inventory available for sale. The inventory classified as a current asset, as the entity would expect to sell it receive cash within next 12 month period o The entitys machinery used to produce the inventory will generate eco benefits beyond the next reporting period non-current A o If an entity secures a term loan in 2013, with it maturing in 2020, the portion of the loan that is to be repaid within next 12 months = current liability.

CHAPTER 5 Balance Sheet Presentation & disclosure of assets, liabilities & equity Assets classes

Cash & cash equivalents cash held @ bank, on hand & in short term deposits. Not a

substantial amount. o
Trade receivables (trade debtors/accounts receivables) amounts due from

customers from sale of G/S o

Inventories (stock) supplies of raw materials used in production process, work-in-

progress and/or finished goods the entity has for sale o

Investments accounted for using the equity method It is the carrying value of

investments in another entity where the investing entity has the capacity to control the investee entity Other financial assets: Financial asset = any asset that is cash, contractual right to receive cash/another financial asset, a contractual right to exchange financial instruments w/ another entity under favourable conditions usually shares Derivative financial asset value depends on the value of underlying security, reference rate/index o
Property, plant & equipment tangible assets that have physical substance, are used in

the operations of the entity & are not intended for sale to customers
o Deferred tax assets Agricultural assets (biological assets) living animals/plants Intangible assets noncurrent, non-monetary assets that dont have physical substance

o o

e.g. brand names, patents, rights, agreements, licenses etc. o

Goodwill unidentifiable intangible asset e.g. an established client base/reputation

Goodwill determination = Purchase consideration MINUS fair value of net assets acquired.

Liabilities

Fair value of net assets acquired = Fair value of A acquired MINUS fair value of L acquired

Trade payables (trade creditors/accounts payable) amounts owed to suppliers for the purchase of G+S

o o

Borrowings debt funding that required interest payments Provisions involves more uncertainty regarding the monetary value to be assigned to the future sacrifice of eco benefits

Other financial liabilities Financial liability

CHAPTER 5 Balance Sheet

Derivative financial liability value depends on the value of an underlying security, reference rate/index

Equity

o o

Share capital (contributed equity) funds contributed to a company by the owners Retained earnings (retained profits/unappropriated profits) cumulative

profits made by the entity that have not been distributed as dividends/transferred to reserve accounts o
Reserves difficult to define because these accounts can be created in a # of ways

Revaluation surplus entities can elect to revalue classes of property, plant & equipment to fair value.

General reserve created by management transferring funds from retaining earnings to a general reserve. Purpose of a general reserve owners that funds (NOT Cash) have been set aside for a purpose to be determined in the future

Foreign currency translation reserve only if the entity has an overseas subsidiary. Accounts of the overseas entity must be converted into domestic currency before consolidation occurs.

Share-based payment reserve (equity-settled benefits reserve) records the fair value @ grant date of shares/options granted to employees & directors as a component of their remuneration. Amounts are transferred into issue capital when options are exercised.

Hedging reserve recognizes gains/losses associated w/ derivative instruments that qualify as hedges.

Non-controlling interests represent claim on the net assets of the entity that belongs to

the shareholders of an entity other than parent entity shareholders. (Present only if parent entity doesnt own 100% of subsidiary entity)

CHAPTER 5 Balance Sheet Measurement of various A&L

Carrying amount (book value) dollar value assigned to an A/L on the BS Historical cost original amount paid/expected to be received for an item Current cost cost of replacing an asset/settling a liability today Realisable (settlement) value amount an entity can expect to receive from disposal of an

asset/settlement of a liability in the normal course of business

Present value sum of the discounted cash flows associated with an item Fair value the price that would be received to sell an asset or paid to transfer a liability

@ acquisition date, the cost price & fair value should be fairly =. But this can diverge as time passes.

Some assets e.g. agricultural assets & derivative instruments MUST be measured @ fair value

Measuring receivables

Carrying amount of receivables on the BS = amount owing MINUS an allownce for amounts expected to be uncollectable.
Allowance for doubtful debts estimate of the amount of accounts receivable expected to be

uncollectable.
Measuring inventory

Carrying amount of inventory must be lower of its cost price/net realisable value. Cost flow assumptions first-in, first-out (FIFO) or weighted average o FIFO method

CHAPTER 5 Balance Sheet

Weighted-average method involves summing the total cost of purchases of a particular item of inventory for the period PLUS any opening inventory, and DIVIDING this by the # of units acquired & on hand @ the start of the period

Measuring non-current assets

ALL non-current A w/ limited useful lives (depreciable assets) must be depreciated. o o Goodwill cant be revalued upwards & must be tested ANNUALLY for impairment Identifiable intangibles e.g. brand names, can be revalued upwards if an active + liquid market exists o o Financial instruments measured @ fair value Agricultural assets fair value MINUS costs to sell

Non-current A carried @ cost/written down cost carrying amount has to be less than recoverable amount (higher of an assets expected fair value and value in use).

Potential limitations of the BS

It doesnt reflect the entitys value o Items creating value for the entity might not be recorded on the BS. These items may fail the definition/recognition criteria e.g. internally generated goodwill employees o A can be measured using different measurement systems & many are recorded @ written-down cost