WEEK 5/6 LECTURE

Covers: Chapter 5 of the textbook up to learning objective 9

on page 172

In this presentation...
1.
2.
3.
4.
5.
6.

explain the nature and purpose of the balance sheet

apply the asset definition and recognition criteria
apply the liability definition and recognition criteria
apply the definition and nature of equity
describe the format and presentation of the balance sheet
describe the presentation and disclosure requirements for
elements on the balance sheet
7. illustrate the measurement of various assets and liabilities
on the balance sheet. (Week 6 lecture)
8. discuss the limitations of the balance sheet. (Week 6
lecture)

Nature and Purpose

of the Balance Sheet
The balance sheet is a financial statement
that details the entitys assets, liabilities and
equity as at a particular point in time the
end of the reporting period
The balance sheet sets out the financial
position of an entity at a particular point in
time

Nature and Purpose

of the Balance Sheet (cont)
The balance sheet is a financial statement that
shows:
what the entity owns (or controls) as at a
particular date the assets
the external claims on the entitys assets the
liabilities (owe)
the internal claim on the entitys assets the
equity (owners)

Balance Sheet Example

Note the formula

Total Assets Total Liabilities = Net Assets = Equity
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The definition
of an asset
An asset is formally defined in the Conceptual
Framework (para. 4.4(a)) as a resource
controlled by the entity as a result of past events
and from which future economic benefits are
expected to flow to the entity. The essential
characteristics for an asset are:
1. the resource must be controlled by the entity
2. the resource must be as a result of a past event
3. future economic benefits are expected to flow to
the entity from the resource.
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Control
An entity must control the item for that item
to be considered as an asset and recognised
on the balance sheet.
The concept of control refers to the capacity
of the entity to benefit from the asset in the
pursuit of its objectives, and to deny or
regulate the access of others to the benefit.

Past Event
Every asset must have arisen from a
transaction that has happened
A company cannot include an asset it will be
getting in the future.

Future Economic Benefit

Items must provide benefits to the entity that
uses them in order to be regarded as assets
Benefit can be cash or control of resources

Recognition of an asset
Recording items in the financial statements
with a monetary value assigned to them.
Satisfying the definition criteria is only part of
the process in recording an item on the
balance sheet
Recognition criteria must also be satisfied

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Recognition of an Asset
Probable
It is more than likely that the future economic
benefits will flow from the asset to the business
controlling it.

Reliably Measured
The value of the asset can be measured reliably
Involves the use of estimates

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Criteria to be satisfied
to recognise an asset
The essential characteristics for an asset are:
1. the resource must be controlled by the entity
2. the resource must be as a result of a past event
3. future economic benefits are expected to flow
to the entity from the resource.
To be recognised as an asset on the balance
sheet, the future economic benefits must be
probable and capable of being measured reliably.
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The definition of a liability

A liability is formally defined in the Framework (para.
4.4(b)) as 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. The essential
characteristics for a liability are:
1. a present obligation to another entity
2. the present obligation arises as a result of past
events
3. an outflow of resources embodying economic
benefits is expected to flow from the entity as a
result of settling the present obligation.
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Present Obligation
A commitment to another entity to provide
resources to that entity.
Can be formal (legal) or informal
Entity may not be known
e.g. sales of goods that may be returned (warranty)

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Past Event
The obligation must have arisen as a result of
a past event
Can be an obligation arising in the future if the
event is currently occurring e.g. court case
Cannot be an obligation you intend to get.

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Outflow of resources
Future sacrifices of economic benefits are
associated with adverse financial
consequences for the entity
Once resources flow out of business, they cannot
be used to generate revenue or obtain assets in
the future.

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Recognition of a Liability
Probable
It is more than likely that the future economic
benefits will flow from the business to another
entity

Reliably Measured
The value of the liability can be measured reliably
Involves the use of estimates

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Criteria for recognising

and recording liabilities
The essential characteristics for a liability are:
1. a present obligation to another entity
2. the present obligation arises as a result of past
events
3. an outflow of resources embodying economic
benefits is expected to flow from the entity as a
result of settling the present obligation.
To be recognised as a liability on the balance
sheet, the outflow of resources embodying future
benefits must be probable and capable of being
measured reliably.
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Presentation and disclosure of

elements on the balance sheet
Accounting standards exist that prescribe the
presentation, classification and disclosure
requirements for assets, liabilities and equity
on the balance sheet
Even though not legally required, some
entities with no public accountability
voluntarily adopt similar classification,
presentation and disclosure practices as
required by IFRSs
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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, 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
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Presentation and disclosure

of assets
Assets are classified according to their nature
or function
Classifications can reflect
Liquidity
Marketability
Physical characteristics
Expected timing of future economic benefits
Purpose
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Classification of Assets
Assets Classes include:

Cash and cash equivalents

Trade receivables
Inventories
Non-current assets held for
sale
Investments accounted for
using equity method

Financial assets
Property, plant and
equipment
Deferred tax assets
Agricultural assets
Intangible assets
Goodwill

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Presentation and disclosure

of assets (example)

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Presentation and disclosure

of liabilities
Liabilities 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
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Classification of Liabilities
Classes include: Trade and other payables
Borrowings
Tax liabilities
Provisions
Financial liabilities
Secured debts
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Presentation and disclosure

of liabilities(example)

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The definition and nature of

equity
Equity is defined in the Conceptual Framework
(para. 4.4(c)) as the residual interest in the
assets of the entity after deducting all its
liabilities.
EQUITY = ASSETS LIABILITIES

Equity comprises various items, including

capital contributed by owners (shareholders)
and profits retained in the entity.
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Presentation and disclosure

of Equity
Depending on the entity structure, the
terminology and equity classifications
appearing on the balance sheet will vary
between entities.
Sole Traders & Partners will have Profit/Loss and
Drawings contributing directly to equity
Companies will have retained earnings and
reserves

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Classification of Equity
Share capital
Paid-up share capital, contributed capital

Retained earnings
Reserves
Minority interests of controlled entities

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Presentation and disclosure

of equity (example)

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Summary
1. The balance sheet reports an entitys
financial position at a point in time
2. Various criteria govern the recognition and
measurement of assets, liabilities and equity
3. A breakdown of various classifications of
assets, liabilities and equity is usually
included in the notes to the accounts
END
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