CHAPTER 5 Balance sheet 193VALUE TO BUSINESS• There are a number of alternative measurement systems that may be used for financial reporting
purposes.
• Accounting standards prescribe different measurement bases for various balance sheet assets and
liabilities.
• The values assigned to items on the balance sheet are referred to as the ‘carrying amounts’,
‘carrying values’ or ‘book values’.
• Assets and liabilities are recorded initially at their cost price.
• Non-current assets with finite lives must be depreciated (or amortised).
• Receivables must be measured at their cash equivalent.
• Inventory must be measured at the lower of cost or net realisable value.
• Entities can choose to measure property, plant and equipment at either cost or fair value. If using the
cost basis, property, plant and equipment cannot be measured at more than its recoverable amount.
If using the fair value basis, the fair value must be regularly assessed and recorded.
• Goodwill cannot be revalued and must be tested for impairment at least annually. Identifiable
intangibles can only be revalued if an active and liquid market exists.
• Some assets such as agricultural assets and derivative instruments must be measured at fair value.
• The balance sheet does not portray the value of the entity.5.11 Potential limitations of the balance sheet
LEARNING OBJECTIVE 5.11 Discuss the limitations of the balance sheet.
In later chapters, we use information extracted from the balance sheet to analyse an entity’s financial
performance and financial position. At this point, it is worth revisiting issues associated with the prep-
aration of the balance sheet because these issues have the potential to affect any analysis involving
figures extracted from the balance sheet.
The balance sheet details the entity’s assets, liabilities and equity as at a particular point in time,
usually at the end of the reporting period. If the business is cyclical, the position purported by the bal-
ance sheet may not necessarily be representative of the position at other times during the reporting
period. For example, due to the peak retail Christmas period, the balance sheet for a retail business with
a December end of reporting period may be different if compared to a June end of reporting period bal-
ance sheet for the same entity.
The balance sheet does not reflect the entity’s value. For example, the net assets of JB Hi-Fi Ltd as at
30 June 2015 totalled $343.5 million on the balance sheet. The market value of the entity’s equity as at
30 June 2015 — as calculated by the share price as at 30 June 2015 ($19.48) multiplied by the number
of shares on issue (98.990 million) — was $1928.3 million, significantly higher than the value depicted
on the balance sheet. The reasons why a balance sheet is not a reflection of an entity’s value include the
following.
- Items creating value for the entity might not be recorded on the balance sheet. Entities may have items
that generate economic benefits or involve future obligations that fail the definition and/or recognition
criteria. For instance, entities cannot recognise internally generated goodwill on the balance sheet. For
many entities, their employees are a valuable resource, but employees are not recognised as assets on
the balance sheet.- Assets can be measured using different measurement systems and many are recorded at their
written-down cost.
- Even if a single measurement system is applied (i.e. historical cost), no consideration is given to differ-
ences in cost prices due to changes in the purchasing power of money. For example, if historical cost
is the measurement basis, land acquired in 2008 for $100 000 would be aggregated with land acquired
in 2015 for $1 000 000, and the value assigned to land on the balance sheet would be $1 100 000.