Unit 3.4 Chp 1-4

30 UNIT 3 FINANCIAL ACCOUNTING FOR A TRADING BUSINESS
Further, because the Accounting equation balances, so too must the Balance Sheet. In
this case, the Total Assets (all economic resources controlled by the business) of $600 000
equals the Total Equities (all claims on those resources, i.e. liabilities plus owner’s equity).
Note also how the term ‘Owner’s equity’ is used as a heading. The actual item
representing the owner’s claim is known as ‘Capital’, with the name of the owner listed
next to it. Any profits earned by the business – and thus increasing what is ‘owed’ to the
owner – would also be listed under the heading of ‘Owner’s equity’.
Review questions 2.2
1 Explain the purpose of preparing a Balance Sheet.
2 Explain the relationship between the Accounting equation and the Balance
Sheet.
3 State the three pieces of information that must be present in the title of every
Accounting report.
4 Explain why the Balance Sheet is titled ‘as at’ a particular date.
5 Explain how the Balance Sheet provides information that is:
• Relevant to the firm’s financial position
• a Faithful representation of the firm’s financial position.
classification
grouping together items
that have some common
characteristic
current asset
a present economic resource
controlled by an entity as a
result of past events that is
reasonably expected to be
converted to cash, sold or
consumed within the next
12 months
non-current asset
a present economic resource
controlled by an entity as
a result of past events that
is not held for resale and is
reasonably expected to be
used for more than the next
12 months
current liability
a present obligation of an
entity to transfer an economic
resource as a result of past
events that is reasonably
expected to be settled within
12 months
non-current liability
a present obligation of an
entity to transfer an economic
resource as a result of past
events that is not required to be
settled within 12 months
2.3 Classification in the Balance Sheet
Given that Accounting exists to provide financial information to assist decision-making,
accountants are always seeking ways to improve the usefulness of the information they
provide. One simple but very effective way of improving the usefulness of the Balance
Sheet is by classifying the information it contains. Classification involves grouping
together items that have some common characteristic. In relation to the Balance Sheet,
the assets and liabilities have already been grouped together, but within these groupings
the items can be classified according to whether they are current or non-current.
Current and non-current assets
All assets are defined as ‘present economic resources’, but an assessment of when
each resource will bring economic benefits determines how they should be classified.
Assets, like cash and other items, that are held primarily for sale or trading or are
reasonably expected to be converted to cash, sold or consumed within 12 months
(that is, are expected to provide an economic benefit only in the next 12 months) are
classified as current assets. Common current assets include the cash in the firm’s
Bank account, the Inventory it is holding for resale, and the amounts owed to it as
Accounts Receivable.
Any assets that are expected to provide an economic benefit for more than 12
months (such as business Premises, Vehicles or Shop fittings) should be classified as
non-current assets.
Current and non-current liabilities
The same ‘12-month’ test applies to liabilities. Current liabilities are obligations that
are reasonably expected to be settled within the next 12 months, such as amounts
owing to Accounts Payable and Loans due in the next year. By contrast, non-current
liabilities are those obligations that must be met some time in more than 12 months.
Longer-term loans, such as Mortgages, are the most common non-current liabilities.
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