Accounting Business Reporting for Decision Making

CHAPTER 5 Balance sheet 195

Summary of learning objectives

5.1 Identify the financial reporting obligations of an entity.

The reporting obligations of an entity vary depending on the nature of the entity. Entities with

public accountability are required to prepare general purpose financial statements in accordance

with approved accounting standards.

5.2 Explain the nature and purpose of the balance sheet.

The balance sheet lists the entity’s assets, the external claims on the assets (the liabilities) and the

internal claim on the assets (the equity). The balance sheet reports the entity’s financial position at a

point in time. The financial position of the entity refers to the entity’s:

• economic resources (assets)


• economic obligations (liabilities)


• financial structure


• financial solvency.

5.3 Outline the effect of accounting policy choices, estimates and judgements on financial
statements.
Even when preparing financial statements in compliance with accounting standards, preparers are
given accounting choices and are required to use estimations and judgements. Users of financial
statements need to appreciate that accounting flexibility, discretion and incentives exist that may
affect preparer’s choices, estimations and judgements, and therefore they need to be aware of the
impact of these choices, estimations and judgements on the financial information reported.

5.4 Apply the asset definition criteria.

The essential characteristics of an asset are:

• a present economic resource


• the resource must be controlled by the entity


• the resource must be as a result of a past event.
  The item does not have to be tangible or exchangeable to be regarded as an asset. An entity can
  always disclose information about items that fail the definition criteria in the notes to the accounts.

5.5 Apply the liability definition criteria.

The essential characteristics of a liability are:

• a present obligation


• to transfer an economic resource


• a result of past events.
  A legal obligation is a liability; however, a non-legal obligation may also be a liability. An entity can
  always disclose information about items that fail the definition criteria in the notes to the accounts.

5.6 Discuss the definition and nature of equity.

Equity is the residual interest in the assets of the entity after the liabilities have been deducted. The

equity balance represents the owner’s or owners’ claims on the entity’s net assets. The equity on the

balance sheet comprises capital that has been contributed by owners, and gains (or losses) accruing

to the entity that are undistributed.

5.7 Apply the recognition criteria to assets, liabilities and equity.

The term recognition refers to recording items in the financial statements with a monetary value

assigned to them. Therefore, ‘asset recognition’ or ‘liability recognition’ means that the asset or

liability is recorded and appears on the face of the balance sheet with its amount included in totals

in the relevant statement. It is recognition that links the elements in financial statements — assets,

liabilities, equity, income and expenses — and hence the financial statements. The linkage between

the statements arises because the recognition of one element (or a change in one element) requires

the recognition of an equal amount in one or more other elements (or changes in one or more