MONASH

BUSINESS
SCHOOL

ACX5903 Accounting for Business

Topic 2
Chapter 2- Measuring & Reporting
Financial Position
Dr. Jin Zhang

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 Learning objectives

• 1. The nature and purpose of the statement of

financial position (the Balance Sheet)
• 2. Definition of assets, liabilities, and equities
• 3. Classifications
• 4. The measurement of assets and liabilities
• 5. Business transaction and accounting equation
• 6. Accounting convention
 Where are we?

• Financial statement—the annual report:

• Management Discussion
• Auditor’s report
• (Consolidated) balance sheet
• (Consolidated) Income statement
• (Consolidated) cash flow statements
• Notes to Accounts
 Nature & Purpose of the
Statement of Financial Position

The Balance Sheet (Statement of Financial Position) is a financial

statement that details the entity’s assets, liabilities and equity as at
a particular point in time — the end of the reporting period
• Commonly 30th June in Australia/New Zealand

It shows
• what the entity owns (or controls) as at a particular date - the assets
• the external claims on the entity’s assets — the liabilities (owe)
• the internal claim on the entity’s assets — the equity (owners)

Equity section depends on business structure (sole trader,

partnership, company)
An example of what’s asset, liability, equity, income
and expenses?

Imagine you earn a living by receiving money for delivering things for people:
You have a $25K truck. It gives you the capability to do deliveries … it is an asset
You borrowed $20K from a bank and used $5K of your own money to buy the truck.
– You have $5K equity in the business
– The bank is owed $20K, therefore the business has a liability of $20K
So, by the way, notice A = L + E; $25K = $20K + $5K
Next day, you earn $100 by making a delivery but you used $20 of petrol to do it.
– $100 is income, $20 is an expense
The difference, i.e. $100 - $20 = $80, is profit.
What can the Balance Sheet tell us?

• What has the entity invested in? Types of assets e.g. inventory
• How much cash does it have and how much in the short term
does it owe?
• About the assets which can be readily converted to cash and
how it compares to the short term cash demands – liquidity
• Use of liabilities (external) relative to equity (internal) to
finance assets
• Types and terms of liabilities
• Sources of equity
• And more
 Assets

Main characteristics:

• A probable future economic benefit

• The business has exclusive right to control the benefit

• The transaction, or other event, establishing control must have

occurred in the past

• The asset must be capable of reliable measurement in monetary

terms

Important: All four conditions must apply

• QS:
• Is Google map an asset for Uber? What about
other public goods?
 Assets

Assets may be:

• Tangible (a physical substance, e.g. land)

– OR

• Intangible (have no physical substance, e.g. patent, data and

information)
 Goodwill

• E.g., the quality of the products, the skill of

employees, the relationship with customers
• Features:
• When the goodwill is generated internally, it is
difficult to determine cost and value, or even to
realize its existence
• To be resolved through ‘arm’s length transaction’
 Claims against Assets

• Other side of statement of financial position includes

claims against the assets of an entity – or simply the
different interests in those assets

• Two types of claims:

o External claims – liabilities

o Internal claims – owners’ equity, equity or capital

 Liabilities

• Claims against assets of the business other than those of

owner(s)

• Recognition criteria (similar to assets):

o probable that an outflow will occur

o capable of reliable measurement in monetary terms

o Examples: accounts payable, bank overdrafts, loans,

subscription received in advance (I urge you to go over
your textbook and get familiar with those glossaries)
 Liabilities

Provision
• Estimated liability, greater uncertainty regarding the amount or
timing of the amount than for a normal liability

Contingent liability
• Potential liability that might arise if a particular event occurs
• Not recognised in financial position until the event actually occurs
 Equity

• Represents the claim of the owner(s) against the business

• Defined as ‘residual interest in the assets of the entity after
deducting all its liabilities’
Typically three categories:
• Owners’ equity contributed – initial funds contributed plus
any specific increases, shareholder capital in case of a
company
• Retained profit (retained earnings) – profits made less any
amounts drawn out by the owners (e.g. drawings, dividends)
• Other reserves – profits that result from other events
 The Classification of Assets
Assets are classified as current where:

• they are held for sale or consumption during the business’s normal
operating cycle
• they are expected to be sold within a year after the date of the
relevant statement of financial position
• they are held principally for trading, and/or
• they are cash, or near-cash (such as easily marketable, short-term
investments)

• All other assets are classified as non-current (regard as being

used to generate wealth in the long term, instead of the
resale purpose)
Examples: Current & Non-current Assets

Current Assets (CA) Non-current Assets (NCA)

• cash at bank • office equipment
• accounts receivable (aka debtors) • motor vehicles
• inventory (aka stock) • property, land
• Supplies (i.e. consumables) • plant and equipment
• short-term investments • goodwill
• Prepaid expenses • patents, trademarks

The classification of an asset may vary according to the nature of the business
 Classification of Liabilities

Liabilities are classified as current where:

• they are expected to be settled within the business’s normal

operating cycle

• they are held principally for trading purposes

• they are due to be settled within a year after the date of the
relevant statement of financial position, and/or

• there is no right to defer settlement beyond a year after the

date of the relevant statement of financial position

All other liabilities are classified as non-current

Examples: Current & Non-current Liabilities

Current Liabilities (CL) Non-current Liabilities (NCL)

• accounts payable (aka • mortgage loan

creditors)
• bank overdraft • long-term loans
• bank loan (repayable within
12 months) • long-service leave
entitlements
• revenue received in advance
(e.g. subscriptions)
• warranty provisions
• staff leave & bonus
entitlements
• provisions for owners’
distributions, tax payable
 Measurement of assets and liabilities

The dollar value assigned to assets and liabilities is called their

carrying amount or book value (most times, book value is to
use historical cost)

Alternative measurement systems include:

– Current cost (cost of replacing the item)
– Market value (expected cash from selling the item)
– Present value (sum of DCF)

So which do we choose?
 Measurement of assets and liabilities

So how do we know what measure to use?

1. No universally accepted answer
2. Financial information is a balance between reliability and
relevance to decision making
3. Although it is common to leave assets at their cost price (or
cost price adjusted for depreciation), entities are also
permitted (and sometimes required) to revalue certain
items to fair value
Valuing Non-Current Assets (NCAs)

Fair value
• An alternative method for recording non-current assets (for current
assets too), provided fair value can be reliably estimated
• Fair value means the current market value (i.e. the exchange value
in an arm’s length transaction)
Impairment of assets
• Where an asset suffers a fall in value, meaning its carrying amount
is higher than the amount that could be recovered from continued
use or sale
• Could be caused by changes in market conditions, technological
obsolescence
• Fall in value written off as a loss
• Impairment also applies to current assets such as inventories
Valuing Non-Current Assets (NCAs)

Non-current assets have lives that are either finite or infinite

• Non-current assets with finite lives ‒ As these assets are used up

over time, their cost is recognised as an expense in each period
• tangible asset: - “depreciation” expense
• Intangible asset: - “amortisation” expense

• Non-current assets with infinite lives ‒ Assets not used up over

time so not subject to routine annual depreciation over time
 Disclosure

Information that doesn’t satisfy recognition and reliability

criteria may be disclosed in the Notes to the Accounts (e.g.
pending legal action).
Notes to the accounts

– Purpose is to explain, provide more information to

clarify figures in the financial statements

– Specify accounting policies chosen

– Provide more detailed data

Example of Disclosure: Notes to the Accounts
Recall - Accounting Data Classifications

• Assets – resources of the business

• Liabilities – what the business owes or others have claim to
• Equity – what the owners own or have rights to
• Income – money/value earned
• Expenses – value/resources consumed

Business events that affect any of these 5 will affect Financial

Statements.
 Recognising business transactions

• Business transactions are occurrences that affect the assets,

liabilities and equity of an entity
• A business transaction is recorded when it can be reliably
measured in monetary terms

• Both assets and liabilities arise from transactions or events

Examples of business transactions

• contribution of capital by owners

• payment of salaries
• receipt of bank interest
• receipt of GST refund
• purchase of laptop on credit
• payment of accounts payable
• depreciating office equipment
• purchase of accounting software
• charging interest on overdue accounts receivable
• payment of advertising
• withdrawal of capital
• cash purchases
• cash sales
• insurance prepayments

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 The Accounting Equation

Expresses the relationship between the assets of the entity

and how the assets are “financed”.

Assets (A) = Liabilities (L) + Equity (E)

A = L + E
 The concept of duality

• Every business transaction has a dual effect

• Every transaction affects the accounting equation in such a
way that the equation remains in balance
• Business transactions are analysed by examining
– the dual effect of each business transaction
– the impact on the accounting equation
Example
– A firm borrows money from a bank to purchase a truck:

A = L + E
 Truck =  Loan
 The Effect of Trading Operations on the
Statement of Financial Position
• Trading introduces additional transactions to the statement of
financial position
• The profit earned over a period of time increases the equity at
the end of the period
• i.e. assuming no drawings or new contributions,
equity at end of year = equity at start of year + profit
Therefore

ASSETS = LIABILITIES + OPENING EQUITY

+ INCOME – EXPENSES

– “Opening” equity means the equity at the beginning of the

period
 Accounting equation

When there are drawings or new contributions:

Drawings – the sole trader or partner withdraws capital from the

business
Dividends – capital is returned to shareholders
Contributions
• sole trader or partner invests more capital
• company issues more shares in exchange for money from
shareholders

Assets = Liabilities + Opening Equity + Income – Expenses +

Contributions – Drawings/Dividends
 Analysis of business transactions

1. Capital contribution
– Owner contributes $50 000 in cash to start a business
– This shows as increase in cash (asset) and increase in
capital (equity)

Assets = Liabilities + Equity

Cash $50 000 = 0 + Capital $50 000
 Analysis of business transactions
2. Asset purchase
– Firm purchases new laptop computer for $3500 and pays
by cash
– This will show as a decrease in cash (asset) and an
increase in office equipment (asset) by the same amount

Assets = Liabilities + Equity

 Cash $3500
 Office equipment $3500
 Analysis of business transactions
3. Income earned
– Firm sends invoice for $3000 for services provided (i.e. the
sale was “on credit”)
– This will show as an increase in debtors or accounts
receivable (asset) and an increase in fees (income) by the
same amount

Assets = Liabilities + Opening Equity + Income – Expenses

 Debtors  Fees
$3000 $3000
 Analysis of business transactions
4. Partner withdraws cash
– Partner “takes out” $5,000 cash to pay school fees
– This will show as a decrease in cash assets and a decrease
in owners equity (increase in Drawings)

Assets = Liabilities + Opening Equity + Income – Expenses - Drawings

 Cash  Drawings
$5,000 $5,000
 Analysis of business transactions

5. “Sold inventory for $12 000 cash. This inventory had cost $8,000”.

When inventory is sold, there are two transactions

• One reflects selling price
• The other reflects cost to the business of what was sold (i.e.
inventory)

• Selling price: Cash ↑, Income ↑ $12,000

• Cost: Inventory ↓, Cost of Sales ↑ $8,000
 Recording of transactions

An accounting worksheet is a means of recording business

transactions
– Good for smaller businesses

Larger businesses will

• Use journals to record individual transactions
• Use ledgers (a system of accounts) to track the effect of
transactions on the balance of accounts
• Journals and Ledgers use debits (Dr) and credits (Cr)
Accounting worksheet
 Accounting worksheet

• Transactions in rows, signified by date on which the

transaction occurred
• Accounts (types of asset, liability, etc) in columns, also Income
and Expenses
• Columns/Account names are selected depending on nature of
the business
• When implemented in the form of a spreadsheet, the columns
can be automatically totalled to give account ‘balance’, i.e.
value

The following example is illustrative of part of what is required

by Assignment 1.
 Example 1. — B. Beetle – Sole Trader

Beetle has been operating a business. The business has the following account
balances at the beginning of January 2025:
Cash At Bank $20,000
Accounts Receivable $ 6,400
Motor Vehicle $12,000
Accounts Payable $ 9,000
Hint: What types of
Bank Loan (due 2032) $30,000 account are these,
Office Equipment $18,000
Office Supplies $ 800 i.e. expenses,
Required: assets, etc?
1. What is the value of equity/capital at the beginning of January?
2. Establish an accounting system by entering the account balances into an
Accounting Worksheet

This example will be completed during the lecture

 Example 1 solution

BALANCE SHEET
Date ASSETS LIABILITIES EQUITY

Vehicle Office Office Acc

Cash Prepayments Vehicles Acc. Dep'n Supplies Equip't dep'n A/Rec A/Pay Bank loan Capital Drawings

o/balances $20,000 $12,000 $800 $18,000 $6,400 $9,000 $30,000 $18,200

$20,000 $0 $12,000 $0 $800 $18,000 $0 $6,400 $9,000 $30,000 $0 $18,200 $0

 Example 2. — B. Beetle – Sole Trader

In January, Beetle:
1 Jan. Bought a van for $4 000
4 Jan. Received a bank loan of $12 000 (9 month term)
5 Jan. Bought some furniture for $8 000 on credit
8 Jan. Delivered $5,000 services to a customer on credit
12 Jan. Paid rent on premises of $1 000 cash
15 Jan. Paid salaries to sales staff of $1 400 cash
24 Jan. Banked cash received in payment of invoiced services $6 000
30 Jan. Received and paid electricity bill for $400
Required:
1. Analyse the transactions and enter them in the worksheet
2. Prepare Income Statement and Balance Sheet
 Example 2 solution

BALANCE SHEET INCOME STATEMENT

Date ASSETS LIABILITIES EQUITY INCOME EXPENSE Notes

Vehicle Office Office Acc

Cash Prepayments Vehicles Acc. Dep'n Supplies Equip't dep'n A/Rec A/Pay Bank loan Capital Drawings

o/balances $20,000 $12,000 $800 $18,000 $6,400 $9,000 $30,000 $18,200

1 Jan -$4,000 $4,000
4 Jan $12,000 $12,000

5 Jan $8,000 $8,000

8 Jan $5,000 $5,000 Services
12 Jan -$1,000 $1,000 Rent
15 Jan -$1,400 $1,400 Wages
24 Jan $6,000 -$6,000
30 Jan -$400 $400 Electricity
$31,200 $0 $16,000 $0 $800 $26,000 $0 $5,400 $17,000 $42,000 $0 $18,200 $0 $5,000 $2,800
 [Link]
(Unadjusted) Balance Sheet
as at 31 January 2025

Assets Liabilities
Cash 31,200 Accounts Payable 17,000
A/Rec 5,400 Loans 42,000
Cars 16,000 59,000
Supplies 800 Owners equity
Off. Equip. 26,000 Capital 18,200
Profit 2,200
20,400
Total Assets79,400 79,400

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Format of statement of Financial Position

Two basic choices:

• Horizontal format – also referred to as the

‘T account’ format

• Vertical format – also referred to as the ‘narrative’ format

Horizontal Format
Example 2.2
 Vertical Format

Two choices within vertical format:

Example 2.3
 Accounting Conventions
1. Business entity convention
For accounting purposes, the business and its owner(s) are
treated as separate and distinct
2. Historic cost convention
Assets should be recorded at their historic (acquisition) cost or
equivalent
3. Prudence convention
Holds that caution should be exercised when making
accounting judgements; often means anticipating losses but
only recognising realised profits
4. Going concern (continuity) convention
Assumption that the business will continue operations for the
foreseeable future, i.e. no intention or need to liquidate the
business
 Accounting Conventions

5. Dual aspect convention

Each transaction has two aspects and each aspect must be
recorded in the financial statements

6. Money measurement convention

Accounting should only deal with those items which are
capable of being expressed in monetary terms

7. Stable monetary unit convention

Money, the unit of measurement, will not change in value
over time
 Usefulness of the Statement of
Financial Position

• Provides insights about how the business is financed and

how its funds are deployed

• Provides insights into the liquidity of the business

• Can provide a basis for assessing the value of the business

• Provides insights into the ‘mix’ of assets held by the business

• Performance can be assessed against amount of investment

BUT …
 Deficiencies & Limitations: Why accounting
numbers can’t be taken at face value:

• Information relevant to your opinion of the business may not be

captured by accounting (e.g. does not satisfy definition &
recognition criteria, e.g. leased property and equipment)

• ‘stable monetary unit’ may not be true, e.g. assets valued in 2010
may be added to assets valued in 2025

• Asset values may be measured in various ways: e.g. at fair value,

or historic cost

• Costs recognised as ‘expense’ or ‘asset’, e.g. advertising, repairs

 Deficiencies & Limitations: Why accounting
numbers can’t be taken at face value:

• Accountants may choose between a range of accounting policies,

e.g. methods of depreciating equipment, estimating bad debts,
valuing inventory

• Accounting numbers may depend on estimations, e.g. useful life

and residual value, % debts unrecoverable, impairments,
realisable value (inventory)
 Consider two businesses …
Company A June 30th 2025 Company B June 30th 2025
• Profit = $5M • Profit = $5M
Assets Liabilities Assets Liabilities
Current $2M Current $1M Current $2M Current $1M
NCA $180M NCL $99M NCA $180M NCL $99M
Equity $82M Equity $82M
Total Assets $182M Total Claims $182M Total Assets $182M Total Claims $182M

• NCA valued at historic cost (30/6/2020) • NCA valued at fair value (30/6/2025)
• ROA = $5M/$182M = 2.74% • ROA = $5M/$182M = 2.74%

Q. Are their ROA performances the same?

What if fair value of Company A’s NCA on 30/6/2025 is 50% higher
than historic cost?
 Consider two businesses …
New Non-current Assets for Company A = 1.5 x $180M = $270M
NCA valued at historic cost (30/6/2020) NCA valued at fair value
Company A June 30th 2025 Company A June 30th 2025
• Profit = $5M • Profit = $5M
Assets Liabilities Assets Liabilities
Current $2M Current $1M Current $2M Current $1M
NCA $180M NCL $99M NCA $270M NCL $99M
Equity $82M Equity
Capital $82M
AR Reserve $90M
Total Assets $182M Total Claims $182M Total Assets $272M Total Claims $272M
ROA = $5M/$182M = 2.74%

New ROA for Company A = $5M/$272M = 1.84%

Now reported to be different from Company B!