By Irene Peter Atolo
When you visit a construction site of a civil engineer and ask him about the building, he will tell you about the basics: the foundation of a building is a sub-structure that carries other super-structures.
Similarly, the balance sheet is the sub-structure of financial statements that carries other super-structures of financial reports. It not only forms the origin of the financial statements but also aids the reading and interpretation, which informs important decisions.
Assuming you register an entity today and pay one million naira to the bank, a balance sheet of a bank asset of one million naira and a liability of equity capital of the same amount can be drawn up and this initial information can form the basis of further decisions and this summary can be done at any time.
As discussed in the previous weeks, users of financial statements require information concerning the economic resources of an entity and claim against it. This statement is known as the statement of financial position or balance sheet.
The statement of financial position summarises the activities of the entity as well as showing the source of financing the assets at a particular point in time.
It has three elements namely assets, liabilities and equities.
It is important to define these elements that constitute the statement of financial position.
Assets are resources controlled by an entity as a result of past events from which future economic benefits are expected to flow into the entity.
This definition is all encompassing as it recognises that the resources of an organisation are not only to be recognised when they are owned by the organisation but, when the resources are under the control of an entity. This is in line with the concept of substance over form which states that transactions have two perspectives namely: legal perspective and the economic substance. It then states that the economic substance of a transaction should be considered when accounting for transactions rather than the legal form.
Classification of Assets
Assets are classified either as non-current or current.
Also, assets can be classified as tangible or intangible.
Non-current assets (fixed assets): these are resources of an entity which are not intended to be used up within an accounting period. This implies that they are not bought for the purpose of resale but primarily for the generation of economic inflow to the organisation. They are principally financed through long-term liabilities or through equity. Examples of Non-current assets include Land, building, plant and machinery, motor vehicle, etc.
Current Assets are resources of an entity which can be used up within an accounting period. This implies that the resources are primarily held for trading activities. They are used to meet the short term liabilities of the entity as well as running the day to day operations. Examples of current assets include inventories (stock), receivables (debtors), cash at bank, cash in hand, investments in short term securities, etc.
Tangible Assets: These are resources controlled by an entity that have physical existence. They can be seen and touched. Examples include land, motor vehicles, buildings plant etc.
Intangible Assets: These are resources of an entity that do not have physical existence. They cannot be seen or touched. Examples include goodwill, brand name, customer list, patent right, copy right etc.
It is worth noting that the tangibility of an asset does not make it current or non-current. An asset can be tangible and be current or non-current. For the sake of preparing statement of financial position, assets are recorded either as current or non-current.
Recognition requirement of Assets in line with the conceptual framework is that they should be recognised in the financial statement if only:
(a) it is probable that future economic benefits will flow into the entity
(b) the cost or value associated with the item of asset can be reliably measured.
These are present obligations of an entity as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. The most important part of this definition is that a liability must be a present obligation. This implies that it is what the organisation owes which must be settled out of the entity’s resources.
Liabilities are divided into two which include,
1. Non-Current Liabilities
2. Current Liabilities
This is known as long term liabilities. These are present obligations of an entity that may not be settled within a twelve-month period. This implies that the settlement of such obligation exceeds more than one accounting period. Example of non-current liabilities include debentures, preference shares, loan, bonds etc.
The non-current liabilities are the major sources of fund to finance the non-current assets of an entity.
These are present obligations of an entity whose repayment or settlement is within a period of one year. Current liabilities are usually used to finance current assets of an entity. Examples include trade payables (creditors), bank overdraft, short term loans etc.
This is the residual value of assets after deducting all liabilities. The equity holders in an entity are the real owners of the business. The equity components are ordinary share capital, share premium, retained earnings, revaluation reserves etc.
The statement of financial position is important because:
(a) It shows the financial position of an entity
(b) It shows the gearing position of an entity
(c) It provides information to investors as well as potential investors in making investment decisions.
(d) It provides information for the preparation of the statement of cash flow.
Finally, statement of financial position is a fundamental test of the accounting equation which states that the resources of an organisation must be equal to what it owes. This can be expressed as assets are equal to equity plus liabilities.
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Frontpage September 25, 2018