Arab Open University

Faculty of Business Studies

B203-B

Business functions in context II

Prepared By Dima Hachem
Chapter 2: Measuring And
Reporting Financial Position
Accounting and finance
Atrill & McLaney
Major Financial Statements
The statement of Cash Flow: shows what cash
movements (cash in and cash out) took place over a
particular period.
The Income Statement or profit and loss account
(statement of financial performance): shows how
much profit or loss was made by the business over a
particular period.
Balance Sheet (statement of financial position):
shows the accumulated wealth of a business at the end
of a period and how the wealth is allocated.
# Together, these statements provide an overall picture of
the financial health of the business.
Prepared By Dima Hachem
 The Statement of Financial Position
(The Balance Sheet)
The purpose of the balance sheet is to set out the financial
position of a business at a particular moment in time. Thus, it
provides an insight to the total wealth of the business. The
status of assets, liabilities and equity of a business are
considered as the financial position of a business. Thus, the
balance sheet balances the assets against the claims (liabilities
and equity) of a business at a particular moment in time.
The balance sheet has been compared to a still photograph, in
that the balance sheet ‘freezes’ a particular moment in time
and will represent the situation only at that moment. Events
may be quite different just before, or just after the particular
moment at which the ‘snapshot’ of the business was taken.

Prepared By Dima Hachem

Assets
Assets are resources owned by the business.
Assets should have the following characteristics:
 A probable future benefit must exist (some future
monetary value)
 The business must have an exclusive right to control
the benefit. (Human resources are not assets)
 The benefit must arise from some past transaction or
event. (purchase must occur prior to considering the item as
an asset)
 The asset must be capable of measurement in
monetary terms (it’s difficult to quantify a brand name as
an asset)
Prepared By Dima Hachem
Examples of Assets
Property
Plant and equipment
Fixtures and fittings
Patents and trademarks (intangible assets)
Trade receivables
Loans made by the business
Inventories
Cash

Prepared By Dima Hachem

The classification of Assets
Current Assets: assets held for the short term:
Inventories
Accounts receivable (amounts owed by customers for
goods/services supplied on credit.)
Cash
Non-current Assets: assets held for long term:
Property
Van
Computers
furniture

Prepared By Dima Hachem

Claims (Liabilities + Equity)
A claim is an obligation on the part of the business to
provide cash or some other form of benefit, to an
outside party. There are 2 types of claims:
Liabilities: represent the claims of all individuals and
organizations other than the owners. Liabilities raise from
past transactions or events such as supplying goods or
lending money to the business.
Equity: represents the claim of the owner(s) against the
business. Also called owner’s capital.
Assets = Equity + Liabilities = Claims
Equity = Assets - Liabilities

Prepared By Dima Hachem

The classification of claims
Current Liabilities: are amounts due for settlements
in the short term (usually about 12 months or less)
Short-term borrowing
Accounts payable (amount owed for the purchase of
goods and services)
Salaries payable
Non-current Liabilities: are amounts due for
settlements in the long term.
Long-term loan

Prepared By Dima Hachem

 Brie Manufacturing
Balance sheet as at 31 December 2008
  $,000
A standard balance Non-current assets  

sheet format Property

Plant and equipment
  45
30
showing : Motor vans 19

- Non-current Assets   94
Current assets  
- Current Assets Inventories 23

# Total Assets Trade receivables 18

Cash at bank 12
- Equity   53

- Opening balance Total assets 147

- profit  
Equity (Owner's capital)
 
 
- Drawings Opening balance 50

- Closing balance Profit 14

Drawings (4)
- Non-current Liabilities  closing balance 60

- Current Liabilities    

# Total Equity + Liabilities Non-current liabilities  

Long-term borrowings 50
Current liabilities  
Trade payables 37
Total equity + liabilities   147
Uses and usefulness of the balance sheet
It provides an insight into how the business is
financed and how its funds are used.
It can provide a basis of assessing the value of the
business.
Relationships between assets and claims can be
assessed. (how much wealth is being carried in
current assets and how much is owed in the short
term).
Performance can be assessed: the effectiveness of a
business in generating profit can be assessed against
the amount of investment that was involved.
Prepared By Dima Hachem
Example 2.1
Cash flow statement
Paul began with £40 of his own money and began the
first day of trading buying £40 of wrapping paper by
cash. First day of trading he bought wrapping paper
for £40 and sold three-quarters (3/4) of it for £45 cash.
Example 2.1
Income statement
First day of trading he bought wrapping paper for £40
and sold three-quarters (3/4) of it for £45 cash.
Example 2.1
Balance sheet
One-fourth (1/4) of wrapping paper was not sold. This
unsold wrapping paper will be charged against future
sales revenue that it generates. The cost of the unsold
inventories is 1/4 of £40 = £10.
Example 2.2
Jerry and company start a business by depositing
$20,000 in a bank account on 1 March. This amount
was raised from
Owner: $6,000
Loan: $14,000

Prepared By Dima Hachem

On 1 March Jerry and company started a business by depositing $20,000 in a bank and money was raised from owner $6,000 and loan $14,000.

Jerry and company

Balance sheet as at 1 March
  $
Assets  
Cash at bank 20,000
   
Total Assets 20,000
   
Claims  
Equity 6,000
Liabilities-borrowing 14,000
Total equity and liabilities   20,000

Prepared By Dima Hachem

Example 2.2 (cont’d)
Consider the following transactions:
2 March: Bought a motor van for $5,000 paying by check.
3 March: Bought inventories on one month’s credit for
$3,000.
4 March: Repaid 2,000 of the amount borrowed to the
lender by check.
6 March owner introduced another $4,000 into the
business bank account.

Question: Draw up a statement of financial

position for the business at the end of each day.

Prepared By Dima Hachem

2 March: Bought a motor van for $5,000 paying by check.

Jerry and company

Balance sheet as at 2 March
  $
Assets  
Cash at bank 15,000
Van 5,000
   
Total Assets 20,000
   
Claims  
Equity 6,000
Liabilities-borrowing 14,000
Total equity and liabilities   20,000

Prepared By Dima Hachem

3 March: Bought inventories on one month’s credit for $3,000.

Jerry and company

Balance sheet as at 3 March
  $
Assets  
Cash at bank 15,000
Van 5,000
Inventories 3000
Total Assets 23,000
   
Claims  
Equity 6,000
Liabilities-borrowing 14,000
Liabilities-trade payable 3,000
   
Total equity and liabilities   23,000
Prepared By Dima Hachem
4 March: Repaid 2,000 of the amount borrowed to the lender by check.

Jerry and company

Balance sheet as at 4 March
  $
Assets  
Cash at bank 13,000
Van 5,000
Inventories 3000
Total Assets 21,000
   
Claims  
Equity 6,000
Liabilities-borrowing 12,000
Liabilities-trade payable 3,000
   
Total equity and liabilities   21,000
Prepared By Dima Hachem
6 March owner introduced another $4,000 into the business bank account.

Jerry and company

Balance sheet as at 6 March
  $
Assets  
Cash at bank 17,000
Van 5,000
Inventories 3000
Total Assets 25,000
   
Claims  
Equity 10,000
Liabilities-borrowing 12,000
Liabilities-trade payable 3,000
   
Total equity and liabilities   25,000
Prepared By Dima Hachem
Example 2.2 (cont’d)
The previous example illustrates the point that the
balance sheet equation (Assets = Equity + Liabilities)
will always hold true because it reflects the fact that, if
a business wishes to acquire more assets, it must raise
funds equal to cost of those assets. The funds raised
must be provided by owner’s equity, or by others
(liabilities) or by a combination of both.
In real life situations, a balance sheet is updated at the
end of a defined reporting period (i.e. monthly,
quarterly , yearly)

Prepared By Dima Hachem

Balancing assets and claims

Prepared By Dima Hachem

If the company decides borrow cash from the bank, the
balance sheet will change accordingly. Current assets
increase because the company getting the cash and non-
current liabilities increase because the company is taking
on more debt:

Prepared By Dima Hachem

The effect of trading operations on the
balance sheet (+)
On March 7, the business managed to sell all of the
inventories for $5,000 and received a check
immediately from the customer for this amount.

Prepared By Dima Hachem

On March 7, the business managed to sell all of the inventories for
$5,000 and received a check immediately from the customer for
this amount.
Jerry and company
Balance sheet as at 6 March
  $
Assets  
Cash at bank 22,000
Van 5,000
Inventories 0
Total Assets 27,000
   
Claims  
Equity (10,000+(5,000-3,000)) 12,000
Liabilities-borrowing 12,000
Liabilities-trade payable 3,000
   
Total equity and liabilities   27,000
Prepared By Dima Hachem
The effect of trading operations on the
balance sheet (-)
What would have been the effect on the balance sheet
if the inventories had been sold on 7 March for $1,000
rather than $5,000?

Prepared By Dima Hachem

What would have been the effect on the balance sheet if the inventories had been sold on 7 March for $1,000 rather than $5,000?

Jerry and company

Balance sheet as at 6 March
  $
Assets  
Cash at bank 18,000
Van 5,000
Inventories 0
Total Assets 23,000
   
Claims  
Equity (10,000+(1,000-3,000)) 8,000
Liabilities-borrowing 12,000
Liabilities-trade payable 3,000
   
Total equity and liabilities   23,000
Prepared By Dima Hachem
The effect of trading operations on the
balance sheet (-)
We can see that any decrease in wealth (that is loss)
will lead to a reduction to the owner’s stake in the
business.
Assets (at the end of the period) =
equity (amount at the start of the period+ profit (or – loss)
for the period)
+ Liabilities (at the end of the period).

Prepared By Dima Hachem

Exercise
 Classify the following items whether they belong to an income
statement or to a balance sheet. Under which heading should they
belong?
Statement/heading Item Statement/heading Item
Accounts Receivable Utilities expense

Sales revenue Accounts payable

Drawing Rent revenue

Depreciation expense Cash
Capital (beginning of the
Note payable (long-term)
year)
Salaries expense Salaries Payable

 Equipment Investment revenue

Gross Profit Cost of goods sold

Net Profit

Prepared By Dima Hachem

Exercise
 Classify the following items whether they belong to an income
statement or to a balance sheet. Under which heading should they
belong?
Statement/heading
Item Statement/heading Item
Balance sheet/current assets Accounts Receivable Income statement / Expenses Utilities expense

Income statement/ revenue Sales revenue Balance sheet / current liabilities Accounts payable

Balance sheet/equity Drawing Income statement/ Revenue Rent revenue

Income statement/expenses Depreciation expense Balance sheet / current assets Cash

Balance sheet / equity Capital (beginning of the Balance sheet / non-current liabilities Note payable (long-term)
year)

Income statement/expenses Salaries expense Balance sheet / current liabilities Salaries Payable

Balance sheet/non-current assets  Equipment Income statement/ Investment revenue

Income statement/direct revenues -

Gross Profit Income statement Cost of goods sold (COGS)
COGS

Income statement Net Profit

Prepared By Dima Hachem

Practice
Prepare a balance sheet for self-assessment question 2.1
on page 71

Prepared By Dima Hachem

Self assessment question 2.1
Item $
Plant and equipment 25,000
Trade payable 18,000
Short-term borrowings 26,000
Inventories 45,000
Property 72,000
Long-term borrowing 51,000
Trade receivable 48,000
Equity at October 2012 117,500
Cash in hand 1,500
Motor vehicles 15,000
Fixtures and fittings 9,000
Profit for the year to 30 September 2013 18,000
Drawings for the year to 30 September 2013 15,000
 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current assets  

 
Current assets

 
Total assets
 EQUITY AND LIABILITIES
Equity

 
Non-current liabilities

Current liabilities

Total equity + liabilities

 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current Assets  
Plant & Equipment 25,000
Property 72,000
Fixtures and fittings 9,000
Motor Vehicles 15,000
  121,000
Current Assets

 
Total Assets
 EQUITY AND LIABILITIES
Equity

 
Non-current liabilities

Current liabilities

Total Equity + Liabilities

 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current assets  
Plant & Equipment 25,000
Property 72,000
Fixtures and fittings 9,000
Motor Vehicles 15,000
  121,000
Current assets
Inventories 45,000
Trade receivables 48,000
Cash in hand 1,500
  94,500
Total assets 215,500
 EQUITY AND LIABILITIES
Equity

 
Non-current Liabilities

Current Liabilities

Total Equity + Liabilities

 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current assets  
Plant & Equipment 25,000
Property 72,000
Fixtures and fittings 9,000
Motor Vehicles 15,000
  121,000
Current assets
Inventories 45,000
Trade receivables 48,000
Cash in hand 1,500
  94,500
Total assets 215,500
 EQUITY AND LIABILITIES
Equity
Opening Balance 117,500
Profit for the year 18,000
Drawings for the year (15,000)
Closing Balance 120,500
 
Non-current liabilities

Current liabilities

Total equity + liabilities

 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current assets  
Plant & Equipment 25,000
Property 72,000
Fixtures and fittings 9,000
Motor Vehicles 15,000
  121,000
Current assets
Inventories 45,000
Trade receivables 48,000
Cash in hand 1,500
  94,500
Total Assets 215,500
 EQUITY AND LIABILITIES
Equity (Owner's capital)
Opening Balance 117,500
Profit for the year 18,000
Drawings for the year (15,000)
Closing Balance 120,500
 
Non-current Liabilities
Long-term borrowings 51,000

Current liabilities
Trade payables 18,000
Short-term borrowings 26,000
44,000
Total Equity + Liabilities
 Simonson Engineering
Balance sheet as at 30 September 2011
 ASSETS
Non-current assets  
Plant & Equipment 25,000
Property 72,000
Fixtures and fittings 9,000
Motor Vehicles 15,000
  121,000
Current assets
Inventories 45,000
Trade receivables 48,000
Cash in hand 1,500
  94,500
Total assets 215,500
 EQUITY AND LIABILITIES
Equity
Opening Balance 117,500
Profit for the year 18,000
Drawings for the year (15,000)
Closing Balance 120,500
 
Non-current liabilities
Long-term borrowings 51,000

Current liabilities
Trade payables 18,000
Short-term borrowings 26,000
44,000
Total Equity + Liabilities 215,500
Exercise 2.4
On 1 March, Joe Conday started a new business.
During March he carried out the following
transactions:
1 March: Deposited £20,000 in a newly opened business
bank account.
2 March: Bought fixtures and fittings for $6,000 cash and
inventories £8,000 on credit.
3 March: Borrowed £5,000 from a relative and deposited
it in the bank.
4 March: Bought a motor car for £7,000 cash and
withdrew £200 in cash for his own use.
Exercise 2.4 (Continued)
5 March: Bought a further motor car costing £9,000. The
motor car bought 4 March was given in part
exchange at a value of £6,500. The balance of
the purchase price for the new car was paid in
cash.
6 March: Conday won £2,000 in a lottery and paid the
amount into the business bank account. He
also repaid £1,000 of the borrowings.

Question: Draw up a statement of financial position

for the business at the end of each day.
Answer:
Answer:
Exercise 2.5
The following is a list of assets and liabilities of
company at a particular point in time.
Short-term borrowings £22,000
Property 245,000
Inventories of raw materials 18,000
Trade payables 23,000
Plant and equipment 127,000
Loan (Long-term borrowing) 100,000
Inventories of finished goods 28,000
Delivery vans 54,000
Write out
Tradeareceivables
statement of financial position.
34,000
Answer:
Exercise 2.6
You must know how to solve
exercise 2.6.
(Answer at the end of the book
in Appendix E on page 764.)
Exercise 2.7
The statement of financial position of a business at the
start of the week is as follows:
Assets £
Property 145,000
Furniture and Fittings 63,000
Inventories 28,000
Trade receivables 33,000
Total Assets 269,000
Equities and Liabilities
Equity 203,000
Short-term borrowings 43,000
(bank overdraft)
Trade payables 23,000
Total Equities and Liabilities 269,000

During the week the following transactions take place:

Exercise 2.7
(a) Sold inventories for £11,000 cash; these inventories had cost
£8,000.
(b) Sold inventories for £23,000 on credit; these inventories had
cost £17,000.
(c) Received cash from trade receivables totaling £18,000
(d) The owner of the business introduced £100,000 of their own
money, which was placed in the business bank account.
(e) The owners bought a motor van, valued at £10,000 into the
business.
(f) Bought inventories on credit for £14,000.
(g) Paid trade payables £13,000.
Required
Show the statement of financial position after all of these
transactions have been reflected.
Answer

Cash at Bank: (43,000) + 11,000+18,000 +100,000 – 13,000 = 73,000

Question
(a)State the purpose of a balance sheet.
(b)Briefly discuss assets and claims with
examples.
(c)Discuss the use and usefulness of the
balance sheet.
Question
ABC Company has the following accounts information at the end of 2016:
Calculate the following :
Current assets
Non-current assets
Current liabilities
Non-current liabilities
Equity of ABC Company.
Question
Best Cake Shop (BCS) is a local business with the
following accounts information at the end of 2013:

Using the above information, prepare a balance

sheet for BCS Company as at 31 December, 2013:
Question
Sarah started a new business on 1 June. During the first month of her business the
following transactions took place:
(a) Sarah opened a bank account in the name of her business and transferred
$50,000 of her own money to it.
(b) She borrowed $35,000 from the Commercial Loan Company and paid the money
into the business bank account.
(c) She paid $40,000 for a small business unit (office).
(d) She paid $3,000 for a second-hand delivery van.
(e) She bought goods for resale (inventories) for $10,000, paying immediately, and
further goods for $20,000, on credit.
(f) She sold goods, which had cost $15,000, for $25,000; $5,000 of this revenue was
for cash and the remaining $20,000 was on credit.
(g) She paid staff wages for June totaling $500.
(h) She received $4,000 from trade receivables.
Open a statement of financial position (Balance sheet) for Sarah’s business
and show each of these transactions on it as a series of pluses and minuses to
reach the position of the business as at the end of June. Show two main
headlines for your balance sheet (“Assets” and “Equity and liabilities”).