ACCT1101 Chap.2 Reading the Statement of Financial Position
Reading the Statement of Financial Position
The statement of financial position reports what a business controls and who has a claim on it, at a single point in time. It is the accounting equation set out vertically, and everything about how it is arranged exists to answer four questions: can the business pay its debts, what is it worth, where is its funding coming from, and is management using its resources efficiently.
The first sorting rule is timing.
An asset is current when the business expects to consume it or turn it into cash inside a year, and non current when it will still be working after that. The same twelve month line splits liabilities.
This is not a judgement about importance: a delivery van is not more valuable than the cash register, it simply sits on the other side of the twelve month boundary.
The common account names are worth learning as a fixed vocabulary, because questions are built from them.
Current assets include cash, accounts receivable, which records what customers owe after a credit sale, inventory, and prepayments, being cash paid in advance for a future expense. Non current assets split into property, plant and equipment, which are tangible, and intangible assets such as copyrights, patents, brand names and goodwill, which lack physical substance.
Current liabilities include a bank overdraft, accounts payable, unearned revenue, being revenue received in advance, and provisions, which are liabilities carrying uncertainty such as warranties. Non current liabilities include long term loans and corporate bonds and debentures.
Equity is where structure reappears.
A company shows share capital, reserves and retained earnings; a sole trader or partnership shows capital, profits and drawings instead. Finally, every account on this statement is permanent: its closing balance this period becomes its opening balance next period, which is precisely what profit and loss accounts do not do.
What this chapter covers
- 01
What the statement reports and the point in time it reports it at
- 02
The twelve month rule that separates current from non current
- 03
Common current asset accounts and what each one records
- 04
Property, plant and equipment against intangible assets
- 05
Common current and non current liability accounts
- 06
Provisions as liabilities carrying uncertainty
- 07
How the equity section changes with the business structure
- 08
Permanent accounts and carried forward balances
- 09
The four decisions the statement is built to support
Sorting a raw account list into a statement that balances
- +1Sort the assets by the twelve month test. Cash $21,400, prepaid fuel $3,600, receivables from clients $34,200 and spare parts inventory $9,800 are all current, totalling $69,000. The vans at $148,000 are used for longer than a year, so they are non current. Total assets are $217,000.
- +1Sort the liabilities the same way. The parts supplier at $12,700 and the wages owed at $6,300 fall due inside twelve months, giving current liabilities of $19,000. The five year loan of $95,000 is non current. Total liabilities are $114,000.
- +1Solve for the residual. Equity is assets less liabilities, so $217,000 less $114,000 gives owner's capital of $103,000. Because equity is defined as the residual, it is the one figure in a question like this you never have to be given.
Key terms
- Current asset
- A resource expected to be used up or turned into cash within one year, such as cash, receivables, inventory and prepayments.
- Accounts receivable
- The current asset recording what customers owe the business after a credit sale, before the cash has been collected.
- Prepayment
- Cash paid in advance of a future expense, held as a current asset until the benefit is consumed.
- Intangible asset
- A non current asset with no physical substance, such as a copyright, patent, brand name or goodwill.
- Provision
- A liability carrying uncertainty about timing or amount, such as a provision for warranties on goods already sold.
Reading the Statement of Financial Position FAQ
Why does the twelve month rule decide the classification rather than the size of the item?
Because the statement is built to answer questions about liquidity and solvency. A reader wants to know what can be turned into cash soon against what is owed soon, and that comparison only works if both sides are cut at the same point. Sorting by size would tell you nothing about whether the business can pay next month's bills.
Is a bank overdraft really a liability when it sits in the bank account?
Yes. An overdrawn account means the bank has lent the business money that is repayable on demand, so it is an obligation arising from a past event that will lead to an outflow of economic benefits. It is listed as a current liability rather than netted against cash, which is why a business can show both cash at one branch and an overdraft at another.
What makes an account permanent rather than temporary?
Permanent accounts carry their closing balance forward to become next period's opening balance, and every account on the statement of financial position does this. Temporary accounts, meaning income and expense accounts, are closed to zero at the end of each period once their net result has been transferred into retained earnings, so they always start a new period empty.
Exam move
Learn the account names before you learn anything else in this topic, because every later question is written in them. Write out the four boxes, current and non current assets, current and non current liabilities, and put at least four named accounts in each from memory.
If you cannot produce the list, no amount of understanding will make a classification question fast.
Then practise the direction you will actually be tested in. You will rarely be handed a tidy statement; you will be handed a jumbled list, and sometimes a wrong one, and asked to comment. Take any list of accounts, deliberately misfile two of them, and hand it to a study partner to find.
Spotting a misfiled prepayment is the exact skill the case study is testing.
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