Topic list Syllabus reference

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(IAS 1: para. 125)
One of the competences you require to fulfil performance objective 7 of the PER is the ability to prepare and review financial statements in accordance with legal and regulatory requirements. You can apply the knowledge you obtain from this section of the text to help you demonstrate this competence.

4. 
   Revision of basic accounts preparation
   

The Study Guide requires you to be able to prepare a basic set of company accounts.
In the next part of this text we move on to the mechanics of preparing financial statements. It would be useful at this point to refresh your memory of the basic accounting you have already studied and these questions will help you. Make sure that you understand everything before you go on.


Basics
Question
A friend has bought some shares in a company quoted on a local stock exchange and has received the latest accounts. There is one page he is having difficulty in understanding.
Required
Briefly, but clearly, answer his questions.

1. 
   What is a statement of financial position?
   
2. 
   What is an asset?
   
3. 
   What is a liability?
   
4. 
   What is share capital?
   
5. 
   What are reserves?
   
6. 
   Why does the statement of financial position balance?
   
7. 
   To what extent does the statement of financial position value my investment?
   

Answer

1. 
   A statement of financial position is a statement of the assets, liabilities and capital of a business as at a stated date. It is laid out to show either total assets as equivalent to total liabilities and capital or net assets as equivalent to capital. Other formats are also possible but the top half (or left hand) total will always equal the bottom half (or right hand) total.
   
2. 
   An asset is a resource controlled by a business and is expected to be of some future benefit. Its value is determined as the historical cost of producing or obtaining it (unless an attempt is being made to reflect rising prices in the accounts, in which case a replacement cost might be used). Examples of assets are:
   

1. 
   Plant, machinery, land and other non-current assets
   
2. 
   Current assets such as inventories, cash and debts owed to the business with reasonable assurance of recovery: these are assets which are not intended to be held on a continuing basis in the business
   

3. 
   A liability is an amount owed by a business, other than the amount owed to its proprietors (capital). Examples of liabilities are:
   

1. 
   Amounts owed to the government (sales or other taxes)
   
2. 
   Amounts owed to suppliers
   
3. 
   Bank overdraft
   
4. 
   Long-term loans from banks or investors
   

It is usual to differentiate between 'current' and 'long-term' liabilities. The former fall due within a year of the end of the reporting period.

4. 
   Share capital is the permanent investment in a business by its owners. In the case of a limited company, this takes the form of shares for which investors subscribe on formation of the company. Each share has a nominal or par (ie face) value (say $1). In the statement of financial position, total issued share capital is shown at its par value.
   
5. 
   If a company issues shares for more than their nominal value (at a premium) then (usually) by law this premium must be recorded separately from the par value as 'share premium '. This is an example of a reserve. It belongs to the shareholders but cannot be distributed to them, because it is a capital reserve. Other capital reserves include the revaluation surplus, which shows the surpluses arising on revaluation of assets which are still owned by the company.
   

Share capital and capital reserves are not distributable except on the winding up of the company, as a guarantee to the company's creditors that the company has enough assets to meet its debts. This is necessary because shareholders in limited liability companies have 'limited liability'; once they have paid the company for their shares they have no further liability to it if it becomes insolvent. The proprietors of other businesses are, by contrast, personally liable for business debts.