BA606 FINANCIAL ACCOUNTING

1. BA606 FINANCIAL ACCOUNTING Professor Garry Carnegie Lectures 7 & 8

2. Lecture 7: The balance sheet • Introduction • Attributes of the balance sheet • Format of the balance sheet • Presentation of balance sheet items • Accounting standards on the balance sheet

3. Introduction • The balance sheet is one of the four key financial statements • The balance sheet records the elements assets, liabilities and equity that meet the definitions and recognition criteria specified • The balance sheet shows the financial position of an entity at a specific point in time (i.e. as at a given date)

4. Introduction • “Financial position”, according to SAC2, “means the economic condition of a reporting entity, having regard to its control over resources, financial structure, capacity for adaptation and solvency” (para. 5) • “Economic condition” refers to the resources controlled by an entity and the claims upon them at a single point in time

5. Attributes • Resources controlled by an entity These are the entity’s total assets Total assets are an “indicator of the command that an entity has over economic resources … As such it depicts the financial size of an entity” (Newman, 1988, p. 28, as per endnote 2 of H, P & H, p. 228)

6. Attributes • Financial structure of an entity The financial structure of an entity refers to the capital structure, that is, the proportion of debt to equity applied in financing assets as well as to its asset structure or the way in which resources have been employed

7. Attributes • Entity’s capacity for adaptation With a view to future actions, an entity’s capacity to adapt refers to its ability “to make significant changes to the form in which … resources are held and/or the manner in which … the activates are financed” (Newman, 1988, p. 30, as per endnote 4 of H, P & H, p. 228)

8. Attributes • Solvency Solvency represents “the availability of assets to meet the financial commitments as they fall due” (SAC2, para. 36) “Solvency refers to the availability of cash over the longer term to meet financial commitments as they fall due” (Framework, para. 16)

9. Attributes • Solvency (cont) Relevant information, “such as disclosure of the liquidity of the entity’s assets and the availability of cash from sources external to the entity, is useful in predicting the ability of the entity to meet its financial commitments, as they fall due, and, therefore, in predicting the ability of the entity to continue to provide goods and services in the future” (SAC2, para. 36)

10. Attributes • Solvency (cont) Short-term solvency refers to the capacity of an entity to meet its short-term liabilities from its short-term assets (i.e. its liquid assets) and is also known as the liquidity of an entity “Liquidity refers to the availability of cash in the near future after taking account of financial commitments over this period” (Framework, para. 16)

11. Attributes • Solvency (cont) Long-term solvency refers to the capacity of an entity to meet its liabilities over the longer term which requires a consideration of an entity’s financial structure and operating performance

12. Format • Authoritative literature has been sparse • Issued in 1963, the Statement of Accounting Practice (or recommendations) on the topic was withdrawn in 1979 • Corporations Act (i.e. Schedule 5 of the Corporations Regulations) and ASX listing rules became the major influences on the preparation of the balance sheet

13. Format • Table 8.1 (H, P & H, p. 219) illustrates the “fixed” format of a balance sheet that was to be prepared in accordance with Schedule 5 • In 1997, Schedule 5 was replaced by AASB 1034 “Information to be Disclosed in Financial Reports” • In 1999, AASB 1040 “Statement of Financial Position” was issued • Now AASB 101 “Presentation of Financial Statements” applies and more flexibility is available in presenting the balance sheet • AASB 101 replaced AASB 1034 and AASB 1040

14. Format • It is argued that a flexible format: - is required to cater for different types of industries, different entity structures and changing environmental influences - permits the selection of information that is relevant to specific entities rather than to adopt a general format for all entities

15. Presentation • Presentation of assets • Assets may, in general, be classified by reference to the following bases: - tangibility - nature - source - longevity - liquidity

16. Presentation • Presentation of liabilities • Liabilities may also be classified in a number of ways • Longevity is the most common classification • Liabilities can also be separated into monetary and non-monetary liabilities

17. Presentation • Presentation of equity • Equity represents the residual net assets of the entity • Decisions relating to the recognition and measurement of assets and liabilities will affect reported equity • “Issued capital and reserves attributable to equity holders of the parent” as well as any “minority interest” are to be disclosed in the balance sheet

18. Accounting Standards • AASB 101 “Presentation of Financial Statements” prescribes: - the components of a financial statement - considerations for an entity in presenting financial statements - classification of items in financial statements - a range of disclosures to be provided

19. Accounting Standards • AASB 101 does not require a fixed format “statement of financial position” • Entities are “encouraged” to adopt one of the two statement of financial position formats as per para. 60: - current/non-current presentation format (see paras. 66-76) - order of liquidity presentation format

20. Accounting Standards • Information to be presented, “as a minimum”, in the statement of financial position is specified in para. 54 • Additional line items, headings and sub-totals are to be presented where they are “relevant to an understanding of the entity’s financial position” as per para. 55 • Information to be presented in either the statement of financial position or in the notes is specified in paras. 77-80

21. Accounting Standards • Materiality and aggregation are dealt with in paras. 29-31 • Assets and liabilities cannot be set-off against each other unless a specific accounting standard prescribes this treatment (paras. 32-35)

22. Lecture 8: Accounting for current assets • Introduction • Accounts receivable • Inventories • Accounting standards for inventories

23. Introduction • “Current assets” are defined in para. 66 of AASB 101 • All other assets shall be classified as non-current • The definition of current assets uses four criteria: - according to the entity’s “normal operating cycle” (according to tradition) as per para. 66(a) - entity “holds the asset primarily for the purpose of trading” as per para. 66(b) - expected realisation “within twelve months after the reporting date” as per para. 66(c) - the asset is “cash or a cash equivalent” as per para. 66(d)

24. Introduction • Current assets normally comprise: - cash assets (including short-term deposits) - accounts receivable - investments maturing within 12 months - inventory

25. Accounts receivable • Accounts receivable are amounts due to the entity as a result of the provision of goods and services on credit terms • Accounts receivable are “derecognised” when reported as doubtful debts expense • Provision for doubtful debts is a “contra-asset” • Accounts receivable are to be disclosed in the statement of financial position under para. 54

26. Inventories • Inventories are goods that are controlled by an entity and are held specifically for future sale or for use in the manufacture of goods for sale • Inventory is also described as stock • Inventories may be classified as merchandise inventory, manufacturing inventory and miscellaneous inventory

27. Inventories • Accounting for inventory has two interrelated purposes: - measure the amount of the asset (inventory) - measure the amount of the cost of goods sold expense

28. Inventories • Cost flow assumptions in accounting for inventory: - average cost - first-in, first-out (FIFO) - last-in, first-out (LIFO)

29. Accounting standards for inventories • Accounting for inventories is dealt with in AASB 102 “Inventories” • The objective of the standard is found in para. 1 • Inventories are defined in para. 6 (also see para. 2) • Net realisable value and fair value are also defined in para. 6 • Disclosures for inventory are found in paras. 36 and Aus36.1 (also see para. 54 of AASB 101)