week 2 lecturer
TRANSCRIPT
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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
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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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Required Exercise – Problem 3.1
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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Required Exercise – Problem 3.1
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
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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)
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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
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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!