1. Week 3
The Balance Sheet
Reference: Chapter 5
pp. 143-172,181-183
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2. Learning Objectives
• Explain the purpose of a Balance Sheet
• Explain and apply the definition of assets and
liabilities
• Explain and apply the definition of equity
• Prepare and interpret a Balance Sheet using the T
format and narrative format
• Explain and apply the measurement of assets and
liabilities to the balance sheet
• Discuss the limitations of the balance sheet
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3. NATURE AND PURPOSE OF THE
BALANCE SHEET
• Presents the financial position of an entity at the
reporting date
• Lists an entity’s assets, liabilities and owner’s
equity at reporting date (at a specific point in
time)
• Reflects
– the assets in which the entity has invested (its
investing decisions), and
– how the entity has financed the assets (its
financing decisions)
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4. NATURE AND PURPOSE OF THE
BALANCE SHEET continued
Balance
Mama Dudes Café date
Balance sheet as at 30 June
2010 2009 2010 2009
Cash at bank 12 000 30 000 Accounts payable 37 000 55 000
Accounts receivable 12 000 14 000 Mortgage 10 000 10 000
Inventory 30 000 28 000 Loans 45 000 45 000
Motor vehicles 40 000 36 000 Total liabilities 92 000 110 000
Buildings 80 000 70 000 Owner’s equity 82 000 68 000
Total assets 174 000 178 000 Total liabilities & equity 174 000 178 000
Reflects duality system & accounting equation
Assets = Liabilities + Equity
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5. Definition of Assets
• Essential characteristics for an asset are:
– the resource must be controlled by the entity
– the resource must be as a result of a past event
– future economic benefits are expected to flow to
the entity from the resource
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6. Definition of Liabilities
• Essential characteristics for a liability are:
– A present obligation to another entity
– 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
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7. THE DEFINITION AND NATURE OF
EQUITY
• Equity is the residual interest in the assets
after the liabilities are deducted
EQUITY = ASSETS – LIABILITIES
• Equity represents the claim of owner/s on the
firm’s assets
• Equity comprises of various items including
– Capital contribution by owners
– Profits retained in the entity
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8. Activity 3.1
• An Italian restaurant called Appetito has established an
outstanding reputation. Every lunch and dinner service the
restaurant is booked to capacity, and there is a 2 month
waiting list for a table for non-regular customers. The
restaurant is famous for its excellent food. The owner
knows that the chef is critical to the restaurant’s fame and
success. The owner believes that the chef is his biggest
asset, and wants to record the chef as an asset on the
business balance sheet. The owner asks for your opinion on
this.
• Can the chef be recorded as an asset on the balance sheet?
Discuss
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9. FORMAT AND PRESENTATION OF THE
BALANCE SHEET
• Two main formats
– T-format
• Assets on left-hand side and liabilities on right-hand side
• Often used for smaller entities
– Narrative format
• Assets, liabilities and equity presented down the page, net
assets is also shown
• Comparative information allows users to see
how firm’s financial position has changed
between the previous and current periods
(shown in example on slide 10)
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10. FORMAT AND PRESENTATION OF THE
BALANCE SHEET (T-format)
Mama Dudes Café
Balance sheet as at 30 June
2010 2009 2010 2009
Cash at bank 12 000 30 000 Accounts payable 37 000 55 000
Accounts receivable 12 000 14 000 Mortgage 10 000 10 000
Inventory 30 000 28 000 Loans 45 000 45 000
Motor vehicles 40 000 36 000 Total liabilities 92 000 110 000
Buildings 80 000 70 000 Owner’s equity 82 000 68 000
Total assets 174 000 178 000 Total liabilities & equity 174 000 178 000
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12. CLASSIFICATION, PRESENTATION AND DISCLOSURE OF
ELEMENTS ON THE BALANCE SHEET
• Accounting standards (rules) exist that
prescribe the presentation, classification and
disclosure requirements for assets, liabilities
and equity on the balance sheet
• Assets and liabilities are generally classified,
which means separated into Current and Non-
Current
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13. 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 (next 12
months), 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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14. Classification in the Balance Sheet
Current Assets –assets that are cash, we will
be used or converted to cash within 12
months e.g. cash accounts receivable,
inventory, supplies, prepayments
Non-current Assets – assets that are not
current assets (i.e. more than 12 months). e.g.
building, land, equipment, motor vehicles
15. Classification in the Balance Sheet
Current Liabilities – the debt is expected to be
settled within 12 months. e.g. Accounts
payable (creditors), wages payable, bank
overdraft, unearned revenue
Non-current Liability – any liability that is not
a current liability. e.g. 3 year bank loan
payable, mortgage payable
16. Current and non-current
assets and liabilities continued
• On the balance sheet, an entity will usually
show total amounts for
– Current asset
– Non-current assets
– Current liabilities
– Non-current liabilities
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17. Classification, presentation and disclosure of
assets, liabilities and equity
• 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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18. Classification, presentation and disclosure of
assets, liabilities and equity continued
Assets – Classes include:
• Cash and cash equivalents • Financial assets
• Trade receivables • Property, plant and
• Inventories equipment
• Non-current assets held for • Deferred tax assets
sale • Agricultural assets
• Investments accounted for • Intangible assets
using equity method • Goodwill
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20. Classification, presentation and disclosure of assets,
liabilities and equity continued
• Liabilities and equity 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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21. Classification, presentation and disclosure of assets,
liabilities and equity continued
Liabilities – Classes include:
• Trade and other payables
• Borrowings
• Tax liabilities
• Provisions
• Financial liabilities
• Secured debts
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23. Classification, presentation and disclosure of
assets, liabilities and equity continued
Equity – Classes include (for a company):
• Share capital
– Paid-up share capital, contributed capital
• Retained earnings
• Reserves (e.g. Asset Revaluation Reserve)
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25. Activity 3.2
• Classify the following items as current or non-current
assets, current or non-current liabilities or equity
– Cash at Bank, Loan Payable (due in 5 years), Share Capital,
Accounts Receivable, Tax Payable, Inventory, Retained
Earnings, Land, Equipment
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26. MEASUREMENT OF ASSETS AND
LIABILITIES
Different methods of valuation are used for
different assets and liabilities on the balance
sheet.
Following are some examples of different
values that are shown for items on the
balance sheet.
The dollar value assigned to assets and
liabilities is called their “carrying amounts” or
“book values”.
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27. MEASUREMENT OF ASSETS AND
LIABILITIES continued
• Assets and liabilities initially recorded at their
historical cost (original cost).
• Non-current assets can continue to be recorded
at historical cost, or can be revalued to fair value
(market value).
• Inventory must be valued at the lower of its cost
price and estimated selling price.
• Accounts receivable must be shown at the
amount that is estimated to be collectable.
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28. Measuring non-current assets
continued
• All non-current assets with limited useful lives
must be depreciated
• Land is not depreciated
• Depreciation is the allocation of the cost of the
asset to expense over its useful life
• On balance sheet, depreciable assets are carried
at their cost (or fair value) less accumulated
depreciation (accumulated depreciation is the
sum of all depreciation expense for the asset)
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29. Activity 3.3
• The following is an extract from the balance sheet:
Balance Sheet (extract) $000 $000
Land at independent valuation 5,860
Buildings at fair valuation 3,790
Less Accumulated Depreciation 1,270 2,520
Plant and Equipment at cost 9,460
Less Accumulated Depreciation 5,510 3,950
Total Property, Plant and Equipment 12,330
• As a user of the balance sheet, what does the $12,330
total property, plant and equipment asset value mean
to you?
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30. Activity 3.4
• From the following account balances of Daisy Pty Ltd as at
30 September 2011, prepare a balance sheet in both the T-
format and the narrative format:
Accounts receivable (net) 25,000
Cash at Bank $50,000
Equipment 6,000
Inventory 20,000
Land 25,000
Loan Payable (due in 2020) 5,000
Retained Earnings 96,000
Share Capital 20,000
Tax Payable 5,000
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31. POTENTIAL LIMITATIONS OF THE
BALANCE SHEET
1. Shows asset, liability and equity values at a
particular point in time and may not be
representative of other points in time
2. The entity’s value is not reflected due to:
– Items that generate future benefits or involve
future sacrifices and cannot be measured reliably
in dollars are not shown
– The historical nature (or combinations of cost and
fair values) of the balance sheet
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32. POTENTIAL LIMITATIONS OF THE
BALANCE SHEET continued
3. Preparing a balance sheet involves:
– management choices
– judgements
– estimations
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33. Summary
• The balance sheet reports an entity’s financial
position at a point in time
• A balance sheet may be presented in a
narrative or T-format
• Asset and liabilities are classified into current
and non-current to provide for useful
information for decision-making
• Different ways are used to measure different
assets and liabilities on the balance sheet
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34. Homework Questions
• The following homework questions should be
completed from the textbook before class in week
4:
Chapter 5
Comprehension Questions 5.2, 5.3, 5.7 page 187
Exercises 5.17, 5.18, 5.24 parts a to d, 5.11
pages 192-193
Problem 5.34 page 195
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