1. The balance sheet shows three things
Week 3 Assets Explain the nature and purpose of the balance sheet (Notes, p154) 1. The balance sheet shows three things – all stocks! 1) What the entity controls at a particular point – The assets 2) What external claims there are on the assets – The liabilities 3) What internal claims there are on the assets – Equity Resources controlled = Claims on resources Assets = Liabilities + Equity 2. The purpose of balance sheet: • Profit business aim to increase value – To do this, firms make investing decisions to acquire assets that create value • These assets need to be purchased by raising funds – Assets are financed from outside the firm (liabilities), or from the owners (equity) – This is the financing decision • The balance sheet helps us identify assets, liabilities and equity.
Why consolidated? – The advantage of a company - Separate Legal Entity - Thus setting up each part of a business as a separate company can help limit losses across the whole company. (i.e. if one Woolworths store goes bankrupt, losses are limited to the one store, the rest of the company is not directly responsible) - Accounting entity (consolidated entity = parent entity + subsidiary entity) concept though means it’s the one business.
Explain the relevance of asset classification (grouping of similar assets) • Balance sheet broken up into current and non-current (time) – Current: upcoming period – thus affects next period’s performance (Assets whose benefits are expected to be fully utilized within one year/normal operating cycle) – short term profit – Non-current: future periods (Assets whose benefits are NOT expected to be fully utilized within one year/normal operating cycle) – long term profit • Also broken up into asset classes – Group similar assets together easier for users to understand – More details in notes (including sub classes)
Outline and discuss the different major classes of assets (including intangibles) Discuss the principles of measurement and valuation applied to different asset classes Current assets:
1. Cash and cash equivalents (Judgement around what is Equivalent) – cannot just compare cash/number (maybe investment involved) Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. 1) Cash equivalents (E.g. Term deposit at call, tradeable short-term bond) - Highly liquid - Short term (different term period among business – Woolworth vs. Drug store – for investment converted to cash equivalent) - Available to meet cash commitments - Convertible to known amount of cash - Insignificant changes in value 2) Investment (E.g. investment in bonds, shares, term deposit with penalty to withdraw) - Less liquid - Longer term - Risk of changes in value 2. Accounts receivable/trade receivables (Judgement around what is collectable) • These are amounts owed to you by customers or similar parties 1) Questions that we need to ask: – Why offer credit? Increase sales – What are the risks? Bad debts – What can we do to reduce the risk? Credit check/charge of interest/discount – So what can we say about trade receivables item? – Is it probable we will receive everything owed? – If we show 100% of trade receivables is it a faithful representation? no
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2) Definition of an asset Control – amounts are legally owed to creditor Future benefit – what to collect Past event/transaction - what caused it
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3) Recognition criteria – Probable (making people pay/receive FB) Is it probable that everyone who legally owes Harvey Norman will pay? No – what is probable to collect? – this is the future benefit
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4) Recognition criteria – Reliable measurement (who want to pay) Need to estimate what can be collected – not faithful representation • Past history • Economic conditions • Age of the debt
3. Inventory (‘stock’ or ‘stock in trade’)
• Goods or property held for sale in the ordinary course of business • Does not include assets acquired to operate the business (e.g. plant and equipment) inventory vs. PPE • Determination of profit is a major objective of accounting for inventory
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1) Definition of an asset Control – not an issue as sb. has the inventory Future benefit – from selling the item Past event/transaction – sb. purchased the inventory
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2) Recognition criteria – Probable Is it probable that Harvey Norman is able to sell all its inventory?
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3) Recognition criteria – Reliable measurement Normally measured at cost • Assumption – this is the minimum future benefit (? – to set the last stock at lower prices in order to sell them). • Assumptions in manufactured costs Assumptions (Inventory Cost Flow Assumption) around what inventory is on hand • FIFO (supermarket – first in first out [faithful representation] – the newest production is taken – need to measure at the cost of the old model which is in the later order – need to drop the last price of old model in order to sell them – minimum future profit [probable to sell]), Weighted Average (mixture of goods) and Specific Identification (high value of single good – easy to identify, costly to measure) • Choose most relevant and faithful (?) What if can’t be sold at cost? • Valued at lower of Net Realisable Value (NRV) or Historical cost. (NRV = Selling price – Cost of sale)
Non-current assets (PPE): • The dollar value assigned to assets and liabilities is called their carrying amount or book value • Two main ways to measure assets post recognition – Historical cost less accumulated depreciation – Fair value 1. Depreciation and historical cost (not valued annually) • All assets with limited useful life must be depreciated – Land is not normally depreciated • Depreciation is the allocation of the depreciable amount of the life of the asset (use of future profit) – Depreciation is the systematic allocation of the cost of a tangible (intangible) asset over its useful life • On balance sheet, depreciable assets are carried at their cost (or fair value*) less accumulated depreciation 2. Fair value (market value/Realisable or Settlement value) – for which an asset could be exchanged, or a liability settled
Why consolidated? – The advantage of a company - Separate Legal Entity - Thus setting up each part of a business as a separate company can help limit losses across the whole company. (i.e. if one Woolworths store goes bankrupt, losses are limited to the one store, the rest of the company is not directly responsible) - Accounting entity (consolidated entity = parent entity + subsidiary entity) concept though means it’s the one business.
Explain the relevance of asset classification (grouping of similar assets) • Balance sheet broken up into current and non-current (time) – Current: upcoming period – thus affects next period’s performance (Assets whose benefits are expected to be fully utilized within one year/normal operating cycle) – short term profit – Non-current: future periods (Assets whose benefits are NOT expected to be fully utilized within one year/normal operating cycle) – long term profit • Also broken up into asset classes – Group similar assets together easier for users to understand – More details in notes (including sub classes)
Outline and discuss the different major classes of assets (including intangibles) Discuss the principles of measurement and valuation applied to different asset classes Current assets:
1. Cash and cash equivalents (Judgement around what is Equivalent) – cannot just compare cash/number (maybe investment involved) Cash equivalents are held for the purpose of meeting short-term cash commitments rather than for investment or other purposes. For an investment to qualify as a cash equivalent it must be readily convertible to a known amount of cash and be subject to an insignificant risk of changes in value. 1) Cash equivalents (E.g. Term deposit at call, tradeable short-term bond) - Highly liquid - Short term (different term period among business – Woolworth vs. Drug store – for investment converted to cash equivalent) - Available to meet cash commitments - Convertible to known amount of cash - Insignificant changes in value 2) Investment (E.g. investment in bonds, shares, term deposit with penalty to withdraw) - Less liquid - Longer term - Risk of changes in value 2. Accounts receivable/trade receivables (Judgement around what is collectable) • These are amounts owed to you by customers or similar parties 1) Questions that we need to ask: – Why offer credit? Increase sales – What are the risks? Bad debts – What can we do to reduce the risk? Credit check/charge of interest/discount – So what can we say about trade receivables item? – Is it probable we will receive everything owed? – If we show 100% of trade receivables is it a faithful representation? no
– – –
2) Definition of an asset Control – amounts are legally owed to creditor Future benefit – what to collect Past event/transaction - what caused it
– –
3) Recognition criteria – Probable (making people pay/receive FB) Is it probable that everyone who legally owes Harvey Norman will pay? No – what is probable to collect? – this is the future benefit
–
4) Recognition criteria – Reliable measurement (who want to pay) Need to estimate what can be collected – not faithful representation • Past history • Economic conditions • Age of the debt
3. Inventory (‘stock’ or ‘stock in trade’)
• Goods or property held for sale in the ordinary course of business • Does not include assets acquired to operate the business (e.g. plant and equipment) inventory vs. PPE • Determination of profit is a major objective of accounting for inventory
– – –
1) Definition of an asset Control – not an issue as sb. has the inventory Future benefit – from selling the item Past event/transaction – sb. purchased the inventory
–
2) Recognition criteria – Probable Is it probable that Harvey Norman is able to sell all its inventory?
–
–
–
3) Recognition criteria – Reliable measurement Normally measured at cost • Assumption – this is the minimum future benefit (? – to set the last stock at lower prices in order to sell them). • Assumptions in manufactured costs Assumptions (Inventory Cost Flow Assumption) around what inventory is on hand • FIFO (supermarket – first in first out [faithful representation] – the newest production is taken – need to measure at the cost of the old model which is in the later order – need to drop the last price of old model in order to sell them – minimum future profit [probable to sell]), Weighted Average (mixture of goods) and Specific Identification (high value of single good – easy to identify, costly to measure) • Choose most relevant and faithful (?) What if can’t be sold at cost? • Valued at lower of Net Realisable Value (NRV) or Historical cost. (NRV = Selling price – Cost of sale)
Non-current assets (PPE): • The dollar value assigned to assets and liabilities is called their carrying amount or book value • Two main ways to measure assets post recognition – Historical cost less accumulated depreciation – Fair value 1. Depreciation and historical cost (not valued annually) • All assets with limited useful life must be depreciated – Land is not normally depreciated • Depreciation is the allocation of the depreciable amount of the life of the asset (use of future profit) – Depreciation is the systematic allocation of the cost of a tangible (intangible) asset over its useful life • On balance sheet, depreciable assets are carried at their cost (or fair value*) less accumulated depreciation 2. Fair value (market value/Realisable or Settlement value) – for which an asset could be exchanged, or a liability settled
