accounts

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Balance Sheet
Principles of Accounting and Finance
Lecture 2
Measuring and reporting financial position
This lecture and its associated materials have been produced by Thanachart Ritbumroong, Ph.D. of iAcademy for the
purposes of lecturing on the above described subject and the material should be viewed in this context. The work does
not constitute professional advice and no warranties are made regarding the information presented. The Author and
iAcademy do not accept any liability for the consequences of any action taken as a result of the work or any
recommendations made or inferred. Permission to use any of these materials must be first granted by iAcademy.

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Agenda
• Week 2 Lecture Coverage
– Financial Statements
– Balance Sheet
– Items in Balance Sheet
– Accounting Convention underpinning Balance Sheet

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Review of Week 1
• What is the difference between financial
accounting and management accounting?
• What are the main characteristics of a limited
company?
• “Comparing 20X2 financial statements of
ExxonMobil with its 20X1 financial statements to
know whether performance and position
improved or deteriorated” – is the example of
which key characteristic of accounting
information?

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Let’s get started with Lecture 2
Balance Sheet

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How should accounting
information be
organized and presented?
• Which information to be presented?
• How information is grouped?

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Chapter Learning Outcomes
• Explain the nature and purpose of the three
major financial statements.
• Interpret the information presented in a
balance sheet.
• Discuss the accounting conventions
underpinning the balance sheet.
• Discuss the limitations of the balance sheet in
portraying the financial position of a business.

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The major financial statements
• There are three major financial statements:
– The balance sheet shows the accumulated wealth at
a particular point in time.
– The income statement shows the wealth (profit)
generated over a particular period.
– The cash flow statement shows the cash
movements over a particular period.
• Watch the VDO and discuss
– Financial Statements

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Any Questions?

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The three statements
Cash flow
statement
What cash movements (that is, cash in and cash out)
took place over a particular period?
• These three are concerned with answering the
following questions
Income
statement
How much wealth (that is, profit) was generated, or
lost, by the business over that period? (Profit (loss) is
defined as the increase (decrease) in wealth arising
from business activities.)
Balance
sheet
What is the accumulated wealth of the business at
the end of that period and what form does the
wealth take?

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The relationship
The balance sheet is
concerned with measuring
the stock of wealth at a
particular moment in
time.
The income statement and cash flow
statement are concerned with
measuring flows of wealth and cash
(respectively) over time.
20X1 20X2 20X3

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Any Questions?

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The balance sheet
• The purpose of the balance sheet is simply to
present the financial position of a business at a
particular moment in time.
• Its alternative name is statement of financial
position.
• It shows the assets of the business on the one
hand, and the claims against the business on
the other.

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The balance sheet
• Watch the VDO and discuss
– What is a Balance Sheet
– Balance Sheet Overview - Assets, Liabilities, Owner's
Equity

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Assets
• An asset is essentially a resource held by the
business with the following characteristics for
accounting purposes;
– A probable future benefit must exist.
– The business must have an exclusive right to control
the benefit.
– The benefit must arise from some past transaction
or event.
– The asset must be capable of measurement in
monetary terms.

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Examples of Assets
• Property, plant and equipment
– Building, cars, trucks, machines, etc.
• Fixtures and fittings
– Built-in furniture, CCTV systems, etc.
• Patents and trademarks
– Logos
• Account receivables (debtors)
– Credit sales

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• Assets that have a physical substance and can
be touched are referred to as tangible assets.
• Assets that have no physical substance but
which, nevertheless, provide expected future
benefits (such as patents) are referred to as
intangible assets.
• Examples – software, patents
** Note that an asset does not have to be a
physical item – it may also be a nonphysical
right to certain benefits. **

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Claims
• Claims are obligations on the part of the
business to provide cash, or some other benefit,
to outside parties.
• Claim will normally arise as a result of the
outside party providing funds in the form of
assets for use by the business.
• Claims are of two types: equity and liabilities.

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Equity
• It represents the claim of the owner(s) against
the business.
• It is also known as Capital.

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Liabilities
• Liabilities represent the claims of all other
individuals and organisations, apart from the
owner(s).
• Liabilities must have arisen from past
transactions or events such as supplying goods
or lending money to the business.
• When a liability is settled it will normally be
through an outflow of assets (usually cash).

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depositing £20,000 in
a bank account
1 March, Jerry and Company start a business
from the owner (£6,000) from borrowing (£14,000)
What is the total worth of all assets?
How much is the owner’s equity?
How much are the total claims?

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Here is how a balance sheet of Jerry and Company
should look like
Assets = Equity + Liabilities
**It is often referred to as the balance sheet equation**
Jerry and Company
Balance sheet as at 1 March
£ £
Assets Claims
Cash at bank 20,000 Liability – borrowing 14,000
Equity 6,000
20,000 20,000

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Summary - Assets, Liabilities, and
Equity
• Watch the VDO and discuss
– Assets, Liabilities, and Stockholders Equity
– Owner's Equity
– Balance Sheet Equation

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Any Questions?

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The balance sheet always ‘balances’
• The balance sheet equation (assets equals
equity plus liabilities) will always hold true.
• If a business wishes to acquire more assets, it
must raise funds equal to the cost of those
assets.
• The funds raised must be provided by the
owners (equity), or by others (liabilities) or by a
combination of the two.

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2 March, Jerry and Company Bought a motor van for £5,000,
paying by cheque
How does this transaction affect
the total worth of all assets?
decrease the balance at the bank by £5,000
introduce a new asset – a motor van

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• The total assets remain unchanged.
• It is only the ‘mix’ of assets that has changed.
• The claims against the business remain the
same because there has been no change in the
way in which the business has been funded.
Jerry and Company
Balance sheet as at 2 March
£ £
Assets Claims
Cash at bank (20,000 – 5,000) 15,000 Liability – borrowing 14,000
Motor van 5,000 Equity 6,000
20,000 20,000

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3 March, Bought inventories (that is, goods to be sold) on
one month’s credit for £3,000.
How does this transaction affect
the total worth of all assets?
no change at
the moment
The inventories are bought on 3
March, but payment will not be
made to the supplier until 3 April.

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• This transaction introduces another new asset
(inventories) to the balance sheet.
• Since the goods have not yet been paid for, the
claims against the business will be increased by
the £3,000 owed to the supplier, who is referred
to as an account payable on the balance sheet.
Jerry and Company
Balance sheet as at 3 March
£ £
Assets Claims
Cash at bank 15,000 Liability – account payable 3,000
Inventories (stock) 3,000 Liability – borrowing 14,000
Motor van 5,000 Equity 6,000
23,000 23,000

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4 March Repaid £2,000 of the amount
borrowed to the lender, by
cheque.
Let’s try prepare the balance sheet as
at 4 March and 6 March
6 March Owner introduced another £4,000
into the business bank account.

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The repayment of £2,000 of the borrowing
will result in a decrease in the balance at the
bank of £2,000 and a decrease in the lender’s
claim against the business by the same
amount.
Jerry and Company
Balance sheet as at 4 March
£ £
Assets Claims
Cash at bank (15,000 – 2,000) 13,000 Liability – account payable 3,000
Inventories (stock) 3,000 Liability – borrowing
(14,000 – 2,000)
12,000
Motor van 5,000 Equity 6,000
21,000 21,000

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The introduction of more funds by the owner
will result in an increase in the equity
(capital) of £4,000 and an increase in the
cash at bank by the same amount.
Jerry and Company
Balance sheet as at 6 March
£ £
Assets Claims
Cash at bank (13,000 + 4,000) 17,000 Liability – account payable 3,000
Inventories (stock) 3,000 Liability – borrowing 12,000
Motor van 5,000 Equity (6,000 + 4,000) 10,000
25,000 25,000

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Any Questions?

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The effect of trading operations
7 March, sell all of the inventories for £5,000 and received
a cheque immediately from the customer for this amount
increase the balance at the bank by £5,000
decrease all amount of the inventories by £3,000
Balanced?

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£2,000 ?
net increase in
wealth (the profit)
£2,000
sell all of the
inventories, net
worth £3,000
receive a cheque,
worth £5,000

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• The net effect has been to increase assets by £2,000
(that is £5,000 − £3,000).
• The equity of the business has increased by £2,000.
• This increase in equity reflects the increases in
wealth will be to the benefit of the owners.
Jerry and Company
Balance sheet as at 7 March
£ £
Assets Claims
Cash at bank (17,000 + 5,000) 22,000 Liability – account payable 3,000
Inventories (stock) (3,000 – 3,000) - Liability – borrowing 12,000
Motor van 5,000 Equity [10,000 + (5,000 -
3,000)]
12,000
27,000 27,000

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What would have been the effect on
the balance sheet if the inventories
had been sold on 7 March for £1,000
rather than £5,000?
Profit or Loss?

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• The inventories (£3,000) will disappear, but the
cash at bank will rise by only £1,000.
• A total net reduction in assets is £2,000.
• This reduction represents a loss from trading and
will be reflected in a reduction in the equity.
Jerry and Company
Balance sheet as at 7 March
£ £
Assets Claims
Cash at bank (17,000 + 1,000) 18,000 Liability – account payable 3,000
Inventories (stock) (3,000 – 3,000) - Liability – borrowing 12,000
Motor van 5,000 Equity [10,000 + (1,000 -
3,000)]
8,000
23,000 23,000

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the profit (or loss) for the period
impacts on the balance sheet as
an addition to (or a reduction of) equity.

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Any Questions?

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Classification of assets and liabilities
• To help users to understand more clearly the
information that is presented, assets and claims
are usually grouped into categories.
• To help gain a clear impression of the ability of
the business to meet its maturing obligations.
• Assets and liabilities are normally categorised as
being current or non-current.

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Current Assets
• held for sale or consumption in the normal
course of a business’s operating cycle (in most
cases, 12 months)
• expected to be sold within the next year
• held primarily for trading
• cash, or near cash such as easily marketable,
short-term investments
• Examples: cash, account receivables,
inventories

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Non-current Assets
• simply assets that do not meet the definition of
current assets
• held for long-term operations
• Examples: property, plant, equipments, motor
vehicles, computers, computer software,
reference books

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Current Liabilities
• expected to be settled within the normal course
of the business’s operating cycle;
• due to be settled within 12 months following
the date of the balance sheet on which they
appear
• held primarily for trading purposes;
• no right to defer settlement beyond 12 months
• Examples: account payables, short-term
borrowings

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Non-current Liabilities
• amounts due that do not meet the definition of
current liabilities
• Examples: long-term borrowing, bonds
payable, long-term lease obligations

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Summary – Current vs. Non-current
• Watch the VDO and discuss
– Current Assets, Long-Term Assets, Total Assets
– Current Liabilities, Long-Term Liabilities, Total
Liabilities

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Balance sheet layouts
• The horizontal layout sets out the assets on one
side of the balance sheet and the capital and
liabilities on the other side.

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Balance sheet layouts (Cont’)
• The vertical
layout begins
with the assets at
the top of the
balance sheet
and places
capital and
liabilities
underneath.

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Accounting conventions
• Accounting conventions are the rules of
accounting that have evolved to deal with
practical problems experienced by those
preparing financial statements.
• The main conventions relating to the balance
sheet include business entity, historic cost,
prudence, going concern and dual aspect.
• Watch the VDO and discuss
– Accounting Conventions

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Business Entity Convention
• The business and its owner(s) are treated as
being quite separate and distinct.
• This is why owners are treated as being
claimants against their own business in respect
of their investment in the business.

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Historic Cost Convention
• The value of assets shown on the balance sheet
should be based on their acquisition cost (that
is, historic cost).
• Even though recording assets at their current
value would provide a more realistic view of
financial position, reporting assets at their
historic cost is argued to provide more reliable
information.

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Prudence Convention
• Caution should be exercised when making
accounting judgments.
• Uncertainty about the future is dealt with by
recording all losses at once and in full; this
refers to both actual losses and expected losses.
• Profits, are recognised only when they actually
arise.
Greater emphasis is placed on expected
losses than on expected profits.

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Going Concern Convention
This means that were a forced sale to occur due
to discontinuation of operations, there is the
likelihood that assets will be sold for less than
their balance sheet value.
The financial statements should be
prepared on the assumption that the
business will continue operations for the
foreseeable future,
unless this is known not to be true.

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Dual Aspect Convention
• Each transaction has two aspects, both of which
will affect the balance sheet.
• Recording the dual aspect of each transaction
ensures that the balance sheet will continue to
balance.

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Limitations of the Balance Sheet
• Asset valuation
– The ‘benchmark treatment’ is to show property,
plant and equipment at historic cost less any
amounts written off for depreciation. However, fair
values may be used rather than depreciated cost.
• Money measurement
– Certain resources such as goodwill, product brands
and human resources are difficult to measure.
– Money is not a stable unit of measurement – it
changes in value over time.

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Any Questions?

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Summary: Week 2 Lecture
• What are three major financial statements?
• What is the balance sheet equation?
• “property, plant, equipments” - are they current
and non-current assets? Why?
• What is historic cost?
• What are limitations of the balance sheet?

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What to Expect: Week 2 Tutorial
• Balance Sheet Preparation
– Classifications of assets and claims
– Classification of current and non-current

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