194 Accounting: Business Reporting for Decision Making
If the entity elected to value the land at its fair value, independently assessed at $2 000 000, the same
land could be recognised on the balance sheet at $2 000 000.- Preparation of the balance sheet involves choices, assumptions and estimations on behalf of the man-
ager or preparer of the statement. We have just seen how the choice of measurement for land would
affect the value recognised on the balance sheet. As another example, consider an entity with accounts
receivable totalling $50 000. Identifying that 1 per cent of the accounts are impaired would reduce the
carrying amount of the accounts receivable to $49 500. However, increasing the impairment to 5 per
cent of the total amount owed would reduce the carrying amount of the accounts receivable on the
balance sheet to $47 500. This is just one example of how applying different choices, assumptions and
estimations will alter the financial numbers on the balance sheet.- The exercise of judgement and discretion is illustrated by the following statement in JB Hi-Fi Ltd’s
notes to its accounts: ‘the preparation of financial statements requires the use of certain critical
accounting estimates. It also requires management to exercise its judgement in the process of applying
the Company’s accounting policies... Estimates and judgements are continually evaluated and based
on historical experience and other factors’ (JB Hi-Fi Ltd 2015, p. 71). JB Hi-Fi Ltd’s management
makes critical judgements in relation to inventory valuation, impairment of goodwill, and other intan-
gible assets and employee entitlements.- The balance sheet is essentially a historical representation, whereas expected future earnings and
growth potential often influence value.
VALUE TO BUSINESS• When using financial numbers extracted from the balance sheet, we should be aware of the potential
limitations associated with the preparation of the statement.
• The balance sheet portrays the entity’s assets, liabilities and equity at a point in time only, and this
may not be representative of its position at other time points.
• The balance sheet does not reflect an entity’s value due to:- items that generate economic benefits or involve economic sacrifices not being recognised on
the balance sheet as they do not satisfy the definition criteria or there is considerable uncertainty
regarding their measurement - assets and liabilities being recognised at historical cost or a combination of historical cost and fair
value.
• The preparation of the balance sheet involves management choices, judgements and estimations.