Chapter 3 Flashcards
(15 cards)
- What is an Asset?
2. Asset’s main characteristics?
- Asset: resource controlled by the entity as a result of past events, from which economic benefits are expected to flow to the entity.
- Characteristics:
- An expected future economic benefit
- The business has exclusive control rights
- Benefit must arise from some past transaction or event (e.g. piece of machinery agreed to purchase in future is not an asset)
- Future economic benefit is probable
- Must be capable of reliable measurement in monetary terms
- What is a liability?
2. Recognition Criteria of a Liability?
- Liability: a present obligation of the entity arising from past events, the settlement of which is expect to result in an outflow from the entity of resources embodying economic benefits.
- Probability of Occurrence / Reliability of Measurement
What is Owners Equity (OE, or simply “equity”)
The Claim of the owners(s) against the business. “The Residual interest in the assets of the entity after deducting all it’s liabilities”.
What is the Accounting Entity Convention?
The acounting entity convention holds that for accounting purposes, the business and it’s owners are treated separately.
What are the Owner Equity Accounts?
- Owners Equity Contributed
- Retained Earnings (profits left in the business by the owners)
- Reserves (amounts reflecting increases in owners claims - profits that have been appropriated for a particular purpose. Reserves are sometimes set up to purchase fixed assets, pay an expected legal settlement, pay bonuses, pay off debt, pay for repairs and maintenance etc)
What is a NON-CURRENT asset?
An asset which is held with the intention of being used to generate wealth rather than being held for resale.
AKA a non-current asset:
a. is expected to be realised in, or intended for sale or consumption in the normal operating cycle
b. is held primarily for the purposes of being traded
c. is expected to be realised within 12m after the balance sheet date OR
d. is cash or equivalent, unless it is restricted from being used in order to settle a liability 12m+ after the balance sheet date
What is a CURRENT Liability
Amounts due for repayment to outside parties within 12m of the balance sheet date.
AKA a liability is current when:
a. it is expected to be settled in normal operating cycle
b. held primarily for the purpose of being traded
c. due to be settled within 12m after the balance sheet date OR
d. the entity does not have an unconditional right to defer settlement of the liability for at least 12m after the balance sheet date.
What is a NON-CURRENT liability
Those amounts due to other parties which are not liable for repayment within the next 12m after the balance sheet date
How is Owner’s Equity Categorised for companies?
COMPANIES:
- Owner’s Equity
- Reserves
a) Retained earnings
b) other reserves
(FYI: OE can represent a single account for sole traders or partnerships (one each)).
What is the accounting equation?
- Entity approach?
- Propriety approach?
Entity Approach:
A= L + OE
Propriety Approach
OE = A-L
HISTORICAL COST CONVENTION:
Why might current-value reporting (verses historical, which is more commonly used) pose problems for both preparers and users of financial statements?
‘Current value’ could be defined in two ways- either as replacement cost or as selling cost. As seen when buying/selling cars, this is often very different pricing!
Also, there can be practical problems using this method, eg. it can be subjective and based on opinion how much something is currently valued at, especially if it cannot be verified. This leads to financial statements losing their credibility.
Explain the Prudence/Conservatism convention
The convention that holds that financial statements should err on the side of caution, effectively anticipating losses but only recognising profits when they are realised.
(Nb: this can cause issues in that assets become understated and liabilities overstated e.g. impact on share price isn’t good when selling shares!)
What useful information/insight can a Balance Sheet (aka statement of financial position) provide
- The liquidity of the business (ability of the business to meet it’s current liabilities)
- The ‘mix’ of assets held by the business (current vs. non-current)
- The financial structure of the business (eg. does the business depend heavily on outside financing?)
How is Gearing calculated, and what % should be concerning?
(Total debt - cash held) / Shareholder Equity) = Net Gearing %.
Generally between 70-100% should be a focus, although depends on cash flows as to whether it should cause problems
What are potential balance sheet deficiencies?
- Some valuable resources could be left off as it doesn’t satisfy the asset definition test(e.g. Employees as a resource).
- Could be incomplete transactions where the outcome is unknown
- May be assets that wont lend up leading to economic benefit (e.g. uncollectable trade receivables)
- Actual measures used for assets & liabilities can distort the picture
- Generally prepared for one particular audience (E.g. business owners). So leaves off other info useful to others (e.g. social/environmental performance)
- As a static point in time, the balance sheet can’t cope with complex transactions or social/environmental/legal environment
