Chapter 2: Further look at financial statements
The classified statement of financial position (balance sheet)
The statement of financial position, also known as the balance sheet, presents a snapshot of the company’s
financial position—its assets, liabilities, and shareholders’ equity—at a point in time.
To improve users’ understanding of the company’s financial position, companies groups similar types of
assets and similar types of liabilities together.
Assets: current assets, investments, property, land, and equipment, intangible assets, goodwill
Liabilities and shareholders’ equity: current liabilities, not current liabilities, shareholders’ equity Share
capital, retained earnings
These classifications to help readers determine things such as whether the company has enough assets to
pay its debts as they come to due and the claims of short and long term creditors and lenders on the
company’s total assets.
Assets are the resources that a company owns or controls that we’ll provide future economic benefits.
Current assets are those resources whose benefits will be realized within a year and non-current assets are
those resources whose benefits will be realized over more than one year
Current assets: are assets that are expected to be converted into cash or will be sold or used out within
one year of the company’s financial statement date for its operating cycle, whichever is longer.
Operating cycle: of a company is the average time it takes to quote from cash to cash in producing
For merchandising business , by operating cycle means the time it takes to purchase inventory, pay cash to
suppliers, sell the inventory of account, and collect cash from customers
For service business, by operating cycle means that the time it takes to pay employees, provide services on
account, and then collect the cash from customers.
For most businesses, and operating cycle is less than one year.
Common types of current assets include:
1. Cash: most liquid form of asset
2. Short-term investments: our investments in debt securities such as bonds of another company or
equity securities such as shares of another company, that are held in hopes of generating interest
income and/or if gains from profitable the sale in the near term. These are also commonly known as
3. Accounts receivable: our amounts owed to the company by customers who purchased product or
service as on credit
4. Accrued receivable: are amounts owed to do the company for interest, sales tax, rent etc.
5. Notes receivable: are amounts owed to the company by customers or others that are supported by a
written promise to repay such as loan receivable.
6. Merchandise inventory: refers to goods held for sale to customers which can include both finished at
unfinished goods. Inventory is a current assets because it will be sold and converted to cash for
accounts receivable during the year.
7. Supplies: include consumable items such as often as supplies and creating supplies. At their current
assets because they are expected to be used up by the business within the year.
8. Prepaid expenses: represent the cost of things like rent and insurance in a in advance of use. They
are current assets because they reflect unused benefits available to use during the year.
9. Cash equivalents: are very liquid investments in debt securities but can be easily converted into cash
Total current assets must be disclosed there is now described order for current assets to be presented on
the statement of financial position
Refer to illustration 2-2 in page 54
Non-current assets : are not expected to be converted into cash, sold, or used up by the business within
one year of the financial statement and dates for its operating cycle.
Common types of non-current assets includes: 1. Long-term investments: includes multiyear investments in debt securities such as loans, notes, bonds,
or mortgages that management intends to hold to an interest, and equity Securities such as shares of
other companies that management plans to hold for many years to generate investment and revenues
or for strategic reasons. These assets are classified as long-term because they are not readily
marketable or expected to be converted into cash within one year. Often long-term investments are
only way firm as investments.
2. Property, plant, and equipment: are tangible assets with relatively long useful lives that are currently
being used in operating the business. This category includes land, buildings, equipments and furniture.
Land is usually listed first as it has an indefinite life, and is followed by the assets with the next long as
useful life, normally building and so on. Most companies and their car their property, plant, and
equipment at cost however, some companies may choose to record these assets and a fair value instead
which is known as the revolution model. Property, plant, and equipment have estimated useful lives
all over which they are expected to generate revenues and because these assets benefit future periods,
their cost is allocated over their estimated that useful life through a process called depreciation.
Companies calculate depreciation by systematically in signing a portion of the assets cost too expensive
each year. Land also generates revenues but it has infinite life so it doesn’t wear out or lose its value
therefore, land never depreciate.
3. Assets that are depreciate it should be reported on the statement of financial position at cost less than
accumulated depreciation. Accumulated depreciation shows the amount of depreciation taken so far
over the life of the asset. It is known as a Contra asset account that is its balance is subtracted from
the balance of the asset that it relates to. Carrying amount is the difference between cost and
accumulated depreciation also known as net book value or just book value.
4. Intangible assets: are not current assets that do not have physical substance and that are present a
privilege for a right granted to, or helped by, a company. Examples of intangible assets include patents,
copyrights, franchises, trademarks, trade names, and a license that give the company an exclusive rights
of use for a specified period of time. Intangible assets are normally divided into two groups for
accounting purposes: those with definite lives and those with indefinite lives. The cost of intangible
assets with definite useful lives is allocated over these future periods and intangible assets with infinite
life do not do not allocate its cost.
IFRS four of the traded companies recommends the use of the term depreciation to refer to the allocation of
cost over the useful lives of depreciable property, plant, and equipment and the term amortization to refer
to the allocation of the cost of certain kinds of intangible assets.
5. Goodwill results from the accusation of another company when the price paid for the company is
higher than the fair value of the purchased companies net identifiable assets. Goodwill is a cat lady of
Mount St. Louis the difference between the price paid for and the fair value of the assets acquired of the
purchased company. Good will is similar to intangible assets because it has no physical substance but
generates future value. Goodwill cannot be separated from the company and be sold it is determined in
their relation to the acquired company as a whole so the only way it can be sold is to sell the acquired
company. Good of all is not amortized and is the reported separately from other intangibles
Refer to illustration 2-4 in page 55 2-5 in page 56
Other types of assets that do not fit into any of the above classifications are non-current receivables,
deferred income tax assets, and property held for sale.
Deferred income tax assets are present the income tax that is expected to be recovered in a later year or
years due to deductions that a company is able to take when preparing its future corporate income return
Liabilities: are on the dishes that result from past transactions.
Current liabilities: are obligations that are to be paid or settled within one year of the company’s
statement date or its operating cycle.
Common examples of current liabilities include:
1. Bank indebtedness: is a short-term loan from a bank, typically occur in when a company uses an
operating line of credit to cover cash shortfalls.
2. Accounts payable: represents amounts old to buy the company to suppliers for purchases made on
credit. 3. Accrued liabilities: are amounts owed by the company for salaries, interest, sales tax, income tax, and
4. Notes payable: the amounts owed, often to banks but also to suppliers or others, that are supported by
a written promise to repay. Amounts owed to banks are usually known as bank loans payable.
5. Notes can be current or non-current. Long-term notes or non-current notes or loan payable such as
five year bank loan, a portion of the loan is often repayable each year . The portion of the payment due
to be made within the current year is classified as current maturities of long-term debt.
Refer to the illustration 2-6 in page 57
Users of financial statements can look closely at the relationship between current assets and current
liabilities. This relationship is important in evaluating company’s ability to pay its current liabilities.
Non-current liabilities: obligation that are expected to be paid or settled after one year. It is also known
as long-term liabilities
Examples of non-current liabilities include:
1. Notes payable including backed loans payable, mortgage payable, and bonds payable. Mortgage
payable are similar to long term notes but have property pledged as security for the loan. Bonds
payable are used by large corporations and governments to borrow large sums of money.
2. Lease obligations include amounts to be paid in the future on long-term rental contracts used for
equipments or other property.
3. Pension and benefit obligations are amounts companies owe costs and current employees for
4. Deferred income tax liabilities : represent income tax that is expected to be payable in a later year or
years when a company prepares its future corporate income return
Non-current liabilities reported in the statement of financial position are normally accompanied by
extensive notes to the financial statement, which includes the major of the obligations and all but the
Refer to the illustration 2-7 in page 58
Shareholders purchase shares in a company by investing cash. These investments are recorded as either
common or preferred shares. The total of all classes of shares issued is classified as share capital.
Common shares are also known as ordinary shares
Retained earnings are the cumulative profits that have been in retained for use in the company.
Refer to the illustration 2-8 In page 58
Refer to the illustration 2-9 in page 59
Statements prepared using a reverse liquidity order usually shows assets first, followed by shares holders
equity and liabilities. Using the financial statements
Ratio analysis expresses the relationships between selected items of financial statement that.
Liquidity, solvency, and profitability ratios are the three gentle types of ratio that are used to analyze
Liquidity ratios: measure in companies to short-term ability to pay its maturing obligations and to meet
unexpected needs for cash.
Solvency ratios: measure the company’s ability to survive over a long period of time
Profitability ratios: measure a company is operating success for a given period of time
Ratios can give clues about underlying conditions that may not be easy to see when the items of a particular
ratio are examined separately