Accounting Business Reporting for Decision Making

CHAPTER 5 Balance sheet 203

Notes to the accounts:

1. The entity also has a $10 000 bank overdraft.


2. The entity has borrowings of $100 000, on which it pays $14 000 (as shown on the balance sheet)
   in interest and loan repayments per annum.


3. The capital of $60 000 represents the original capital contributed by the owners. It does not
   include subsequent capital injections.


4. The profit of $36 000 is the reported profit for the current reporting period.


5. The inventory is measured at cost price.


6. The goodwill represents the figure that was necessary to ‘balance’ the balance sheet.


7. The plant and equipment is at cost.
   Required
   a. Discuss at least five errors or divergences from acceptable accounting practices revealed.
   b. List three limitations of the balance sheet.

SOLUTION TO 5.3

a. The errors or divergences from acceptable accounting practices include the following.

• The balance sheet does not provide information regarding the categorisation of the assets
  and liabilities as current and non-current. Furthermore, no subtotals for such items are
  detailed.


• Goodwill can be recognised only if it is purchased. Heyday Pty Ltd should not be recognising
  any internally generated goodwill.


• The inventory is measured at cost price. Inventory should be measured at the lower of cost or
  net realisable value. Having the inventory at cost price is acceptable providing that the cost of
  the inventory is higher than the net realisable value.


• No allowance for doubtful debts is provided.


• Assets with limited useful lives must be depreciated, so the plant and equipment should be
  recorded at its cost less accumulated depreciation.


• The balance of retained earnings should be reflected on the balance sheet, rather than just the
  current year’s profit being included in the equity section.


• The $10 000 bank overdraft satisfies the liability definition and recognition criteria, and should
  be included on the balance sheet as a current liability.


• The capital contribution should be the sum of all contributions to the business by the owners,
  rather than restricted to the contributions originally made.


• The borrowings of $100 000 should appear as a liability on the balance sheet.
  b. First, the balance sheet is a historical snapshot of the entity’s economic resources and obli-
  gations at a point in time only and the snapshot presented may not be representative of that at
  other times of the year. Second, it does not purport to show the value of the entity due to the
  existence of assets and liabilities that are not reported on the balance sheet, and fair value not
  being the measurement systems used to recognise all assets and liabilities. Third, the definition
  and recognition of items on the balance sheet involves management choices, estimations and
  judgements.

Comprehension questions

5.4 Discuss whether the following statements are true or false. LO2, 9

a. The terms ‘accounts receivable’ and ‘creditors’ mean the same thing.

b. The balance sheet is a financial statement that shows the financial position of an

entity as at a point in time.

c. Ms Entrep invests her own cash to start a business. This transaction will increase the

equity and statement of changes in