Week 4 - Balance Sheet Flashcards
(22 cards)
What is the purpose of a balance sheet?
Shows the financial position of a business at a point in time.
List of Assets, Liabilities and Owner’s Equity at the point.
Also known as a “Statement of Financial Position”
What are assets?
Items of value owned or controlled by a business.
Can be tangible or intangible
What are the essential characteristics for a resource to be called an asset?
- Must be controlled by the entity
- It must result from a past event
- Future economic benefits are expected to flow to the entity from it.
What is an intangible asset?
Something that has no physical substance, such as goodwill, patents and brand names.
What is goodwill?
The extra amount above a net asset someone is willing to pay for a business. Involves reputation, loyal customers, location, good staff etc etc…
Can only be recorded when purchased
What type of claims are there against a firm’s assets?
External claims (owed to parties other than the owner - i.e. liability)
Internal claims (owed to the owner, made up of capital, profits, losses, withdrawals - i.e. Owners Equity)
What is and are the characteristics of a liability?
Amounts owed by the company.
- A present obligation to another entity exists
- 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
- Recognised (recorded) when it is capable of reliable measurement in monetary terms.
What are some examples of liabilities?
- Creditors (accounts payable)
- Bank Loans
- Unearned revenue (revenue received in advance)
- Provisions for staff entitlements (e.g. long service leave)
- Warranty provisions
What is Owners Equity?
Residual (leftover) interest in the assets after liabilities are deducted.
Equity equals the firms net assets and represents claims of owners on the firm.
What items are included in equity?
- Capital or share capital
- Amounts paid to owners from profits (ST & P called drawings and C called dividends; both reduce owners equity)
- Profits retained from the firm (ST & P added to capital, C in retained earnings/profits; dividends are paid from here)
What is the difference between current and non-current assets?
Current: consumed or converted into cash within the operating cycle (usually 12 months). e.g. cash, inventory, accounts receivable, expenses prepaid.
Non-current: Held for purpose of generating wealth rather than for resale. Normally held for over a year.
E.g. Land, buildings, equipment, patents, trademarks, goodwill.
What is the difference between current and non-current liabilities?
Current: Amounts due for repayment to outside parties within 12 months of Balance Sheet date
e.g. accounts payable, wages, payable, accrued expenses, unearned revenue.
Non current: Amounts due to other parties which are not liable for repayment within the next 12 months.
E.g. Loans payable, mortgage payable.
What is liquidity?
A “liquid” asset is one that is cash or can be quickly converted to cash. It is a rough measure of whether the firm has enough funds to pay current liabilities when due.
What is the “current ratio?”
The ratio of current assets to current liabilities. AKA “working capital ratio.”
- Provides a measure of the firms liquidity
Current Assets/Current Liabilities = liquidity
What is leverage?
How the firm finances its assets. AKA gearing and is the proportion of funds provided by debt (compared to equity). A highly-geared firm has a high percentage of debt.
Liabilities/Assets = Leverage
What is the carrying amount?
AKA book amount or written down value. It the the value of an asset or liability represented on the balance sheet.
What are the possible ways of measuring the book value?
- Historical cost - original cost - initial recording in books
- Current cost - cost of replacing an asset
- Market value - expected cash from selling an asset.
(When market value is used, firms are said to be revaluing the asset. (Recall, this results in a Reserve in Owners Equity). - Present value - discounted cash flows
What are some examples of measurement rules?
Accounts receivable: The amount owing by debtors can be reduced by an allowance for doubtful debts. This allowance is an estimate of amounts un-collectible. On the BS these are shown as “net accounts receivable.”
Inventory rules: Inventory must be valued at cost or market price (whichever is lower). If cost, inventory can be valued using FIFO (first in, first out), weighted average or specific identification.
Non-current assets: Most are carried at cost or revalued. It is common to reduce the value of non-current assets by accumulated depreciation.
Goodwill: Only be recorded when purchased etc.
What is amortisation?
Accumulated depreciation for intangible assets.
What are accounting assumptions?
AKA conventions, concepts or principles, are the foundations of the accounting system used by all businesses. (GAAP)
What are some accounting assumptions?
- Business entity (accounting entity).
The business is accounted for separately from the owner. - Monetary measurement
All items must be expressed in $ terms
-Historic cost
Record all items at acquisition cost
- Going concern
Business will continue to operate into the foreseeable future - Conservatism
Err on the side of caution - Objectivity/relability
must have verifiable evidence of all transactions - Accounting period
The life of the business is divided into time periods for accounting and reporting purposes - Matching
Match revenues earned & expenses incurred in earning that revenue to determine profit (whether cash received or paid or not).
What are some balance sheet limitations?
- Shows A L OE values at one particular point in time only
- The balance sheet adds together dollar values from different periods. The time value of money is not taken into account.
- The balance sheet adds together items measured differently –some recorded at cost; some re-valued.
- Preparing a BS involves management choice & a large number of estimates (so accuracy can vary).
- Because of the accounting assumptions, the picture may not be a complete one because items which cannot be measured in historic cost dollars cannot be included.
- The balance sheet should be interpreted as a “conservative” estimate of the firms true value.
