Week 2 Lecturer

8/11/2019 Week 2 Lecturer

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MIT565702

TOPIC 2

FINANCIAL STATEMENTS AND THEIR

ELEMENTS



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Lecture Objectives

At the end of this lecture you should be able to:

– Understand and apply the definition and recognition

criteria of the elements that make up the balance

sheet and the income statement;

– Understand the difference between recognition and

disclosure of financial statement elements; and

– Complete a balance sheet and an income statementusing transaction analysis



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Problem 1.10

Fred Jones started a consulting business on 1 March 2012. During the

period up to 30 June 2012, the following transactions occurred:(1) Fred put $10,000 of his own money into the business

(2) He borrowed $30,000 from the bank for one year

(3) He sent bills for $35,000 to customers for work performed. By 30 June hehad received $30,000 and expected the other $5,000 in July

(4) He bought a computer for $8,100

(5) He paid $12,000 in wages(6) He paid other expenses of $20,000

(7) He received a $500 bill for advertising (appeared in newspapers in May;will be paid in July)

Required: Record the transactions as they would effect the accounting

equation and prepare the Statement of Financial Position, income statementand Statement of Cash Flows and Statement of changes in owner’s equityfor the four months ending 30 June 2012



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Problem 1.10

ASSETS = LIABILITIES + OWNERS EQUITY

A = L + OE

(1) Cash 10,000 Capital 10,000

(2) Cash 30,000 Loan 30,000

(3) Acc. Rec. 35,000 Sales 35,000

Cash 30,000

Acc. Rec. 30,000

(4) Computer 8,100

Cash 8,100



Problem 1.10

ASSETS = LIABILITIES + OWNERS EQUITY

A = L + OE

(5) Cash 12,000 Wages 12,000

(6) Cash 20,000 Other expenses 20,000

(7) Acc. Pay. 500 Advertising 500

.



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Problem 1.10

Income Statement for the period ended 30 June 2012

Sales 35,000

less Expenses

Wages 12,000

Other expenses 20,000

Advertising 500

Total expenses 32,500

Net profit 2,500



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Problem 1.10

Balance sheet as at 30 June 2012

ASSETSCurrent Assets

Cash at bank 29,900

Accounts receivable 5,000 34,900

Non-current Assets

Computer 8,100

Total Assets $43,000LIABILITIES

Current L iabil i ties

Accounts payable 500

Loan 30,000

Total liabilities 30,500

OWNER’S EQUITY

Capital 10,000

Retained profits 2,500

Total owner’s equity 12,500

Total liabilities and owner’s equity $43,000



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Problem 1.10

Statement of Changes of Owner’s Equity for the period ended30 June 2012

Owner’s Equity at 1 March 2012 0

Owner’s capital contribution 10,000

Net profit (comprehensive income) 2,500

12,500

Less Owner’s drawings 0

Owner’s Equity at 30 June 2012 12,500



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Problem 1.10

Cash Flow Statement for the period ended 30 June 2012

Cash flows from operating activities

Receipts from customers 30 000

Payments to employees (12 000)

Payments for other expenses (20 000) (2 000)Cash flows from investing activities

Purchase of computer (8 100) (8 100)

Cash flows from financing activities

Capital contribution 10 000

Bank loan 30 000 40 000Total net cash flows 29 900

Cash: 1 March 2012 (opening balance) 0

Cash: 30 June 2012 (closing balance) 29 900



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Required Exercise – Problem 3.1

1. ASSETS = LIABILITIES + OWNERS’ EQUITY

Cash Accountsreceivable

Inventory Accountspayable

Rentpayable

Taxpayable

Retainedprofits

Revenue Expenses

$ $ $ $ $ $ $ $ $

a +10,000 +10,000 b +9,600 -9,600 c +6,100 +6,100 d -6,300 -6,300

f 2,400 -2,400 g -2,900 -2,900 h 350 -350 i -450 -450 Total -50 400 6,100 -200 -500 350 -450 10,000 -2,750

6450 = 6450 NB. Increases in expenses have been entered as minus figures.



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Flashy Fashions Pty Ltd

Income statement for the year ended 30 September 2009

$

Sales 10,000

Less Operating ExpensesRent 2,400

Profit before tax 7,600

Less Tax expense 350

Net Profit 7,250



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Flashy Fashions Pty LtdBalance sheet

as at 30 September 2009

Current Assets

$ Current Liabilities

$ Cash 750 Accounts Payable 400

Accounts Receivable 800 Tax Payable 350 Inventory 7000 Prepaid rent 200 Shareholders’ equity

Share Capital 500 Retained Profits 7,500

8,750

8,750



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Questions from other Required Exercises?



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When is an Element included in the

Balance Sheet?

For an element to be included in the balance sheet it must

meet certain requirements

In particular, it must satisfy BOTH:

– the definition criteria; and

– the recognition criteria

These criteria are outlined and explained in the Framework

for the Preparation and Presentation of FinancialStatements (the Framework )



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Framework for the Preparation and

Presentation of Financial Statements

The Framework sets out the concepts that underlie the preparation

and presentation of general purpose financial reports for external

users

The Framework deals with: – the objective of general purpose financial reports;

– the qualitative characteristics of general purpose financial reports

to ensure they are useful to external users;

– the definition and recognition of the elements from whichfinancial statements are constructed (the focus in Week 2); &

– the concepts of capital and capital maintenance



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Framework for the Preparation and

Presentation of Financial Statements

Our aim is to understand and apply the definition and recognition

criteria contained in the Framework

The Framework can be downloaded from the Australian AccountingStandards Board (AASB) website (www.aasb.com.au) or via the

following hyperlink:

http://www.aasb.com.au/admin/file/content105/c9/Framework_07-04nd.pdf

Or IASCF version http://eifrs.iasb.org/eifrs/bnstandards/en/framework.pdf

http://www.aasb.com.au/





http://www.aasb.com.au/



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Definition Criteria for Assets

The essential components of the definition criteria are:

(1) Future economic benefits (service potential)

• Potential to contribute, directly or indirectly, to the flow of

cash to the entity

• Generate cash flows through the sale of, or use of, the

asset

• E.g., a disused mine?



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Definition Criteria for Assets

(2) Control by the entity

• Capacity of the entity to benefit from the asset and deny or

regulate the access of others

• Does not mean ownership (e.g., leases)

(3) Occurrence of past transactions or other past events

• Transaction or other event giving the entity control of the asset

must have occurred

• E.g.,

• Asset purchase

• Non-reciprocal transfer (donation/grant)



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Recognition Criteria for Assets

Once the definition is satisfied, an asset should only be

recognised (included) in the balance sheet if the

recognition criteria are satisfied

The recognition criteria are explained in para. 83 (p.30

AASB, p20 IASCF)

http://www.aasb.com.au/public_docs/aasb_standards_2005/pdf/Framework_07-04.pdf



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Recognition Criteria for Assets

The essential components of the recognition criteria are:

(1) Probable future economic benefits

• More likely than not

• Greater than 50% chance of occurring

(2) Reliable measurement

• Transaction to verify the cost

•

Reasonable estimate• E.g., internally generated goodwill, brand names (Coke)



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Decision Path for Asset Recognition

Does the item have all three essentialcharacteristics of an asset?

Does the asset meet both the recognition criteria?

Details might appear inthe annual report

Asset recognised in theentity’s balance sheet

Separately disclosed inthe notes

No

No Yes

Yes



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Important Terms

Recognised

Included in the balance sheet

Disclosed

Not included in the balance sheet

• Included as a note to the financial statements



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Property Developer- Public Park

Definition Criteria – Future economic benefits

Future economic benefits through the sale of the townhousessurrounding the park

– Control

If access to the park is open to the general public without charge thenthe developer does not have control over the asset

Will the entity be able to deny or regulate the access of others to the

park?

– Past events

Construction of the townhouses and park



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When are Liabilities included in the

Balance Sheet?

The liability definition criteria are outlined in para. 49(b)

(p.22 AASB, p14 IASCF) of the Framework



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Definition Criteria for Liabilities

The essential components of the definition criteria are:

(1) Present obligation

• Legally enforceable obligations (consequences)

• Contractual arrangements (e.g., a bank loan)

• Imposed on the entity (e.g., income tax payable)

• Good business practice or equitable obligations (e.g.,repair faults outside warranty period)

• Does not include future commitments (e.g., decision to purchase asset in the future)

• Discretion



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Definition Criteria for Liabilities

(2) Future outflow of economic benefits

• Settlement of the present obligation

• E.g., bank contract specifies future outflow• Giving up resources to settle the obligation

(3) Occurrence of past transactions or other past events

• Transaction creating the present obligation must haveoccurred

• A present obligation cannot be created by a future

transaction



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Recognition Criteria for Liabilities

Once the definition is satisfied, a liability should only be

recognised (included) in the balance sheet if the

recognition criteria are satisfied

The recognition criteria are explained in para. 83 (p.30

AASB, p20 IASCF)



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Recognition Criteria for Liabilities

The essential components of the recognition criteria are:

(1) Probable future sacrifice of economic benefits

• More likely than not

• Greater than 50% chance of occurring• E.g., a pending decision in a law suit

(2) Reliable measurement

• Transaction to verify the cost

• Reasonable estimate

You will notice these are the same criteria as considered for assets



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Decision Path for Liability Recognition

Does the item have all three essentialcharacteristics of a liability?

Does the liability meetboth the recognition

criteria?

Details might appear inthe annual report

Liability recognised in theentity’s balance sheet

Separately disclosed inthe notes

No

No Yes

Yes



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Student Task

Have a think and chat about the following:

An employee, who suffered injuries while at work,

is suing his employer for damages. The court hasfound in favour of the employee, but is yet to reach

a decision on damages.

Would the damages be included as a liabi l i ty in the

balance sheet of the employer?



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When is Equity included in the

Balance Sheet?

The equity definition criteria are outlined in para. 49(c)

(p.22 AASB, p14 IASCF) of the Framework



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EquityRemember from last week that:

– Equity equals the net assets of the business

– They are the owners’ claim on the business assets after liabilities have been deducted (e.g., liquidation)

ASSETS - LIABILITIES = OWNERS EQUITY

A - L = OE

– Equity derived from:

Contributions by owners; and Accumulated profits not distributed as dividends (retained profits)



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Definition Criteria for Income

Essential components of the definition criteria for income are:

(1) Inflows/enhancements of assets/ or decreases in liabilities

• Cash/credit sale (enhances debtors)/ or forgiveness of debt(e.g., discount received)

(2) Resultant increase in equity

• Increase in retained profits

(3) Other than contributions by equity participants

• Capital contributed by owners



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Recognition Criteria for Income and

Expenses

Once the definition is satisfied, income or expenses

should only be recognised (included) in the income

statement if the recognition criteria are satisfied

The recognition criteria (para. 83) are the same for

assets, liabilities, income and expenses

S



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Student Task – Relationship Between

Income Statement and Balance Sheet

F lowerpot Ltd has the foll owing account balances ($) at 30 June2012:

Accounts receivable 5,000 Accounts payable 3,000Advertising 700 Building 15,000

Cash at bank 4,500 Dividends 2,500

Electricity 800 Furniture 20,000

Inventory 3,600 Bank loan (long-term) 9,000Rent 1,400 Retained profit (1 July, 2010) 9,500

Sales 19,500 Share capital 12,500



Workings – Flowerpot Ltd



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Assets $ $ Liabilities $ $

Current assets Current Liabilities

Cash at bank 4,500 Accounts payable 3,000

Accounts receivable 5,000 Non-current liabilities

Inventory 3,600 13,100 Bank loan 9,000

Non-current assets Total liabilities 12,000

Building 15,000 Shareholders equity

Furniture 20,000 35,000 Share capital 12,500

Retained profit 23,600

Total s’holders equity 36,100

Total assets 48,100 Total liabilities and

shareholders equity

48,100

Flowerpot Ltd

Balance Sheet as at 30 June 2012



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Next Week

The double-entry system of record-keeping!

Week 2 Lecturer

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