Elements of financial statements and their
Question 2: Accounting information
Revenue 150 000
Cost of sales 75 000
Gross profit 75 000
Distribution costs 24 600
Administrative expenses 15 000
Finance costs 8 000
Profit before tax 27 400
Income tax expense 17 000
Profit for the year 10 400
3.3 Purpose of financial statements
Both the statement of financial position and the statement of comprehensive income are summaries of accumulated data. For example, the statement of comprehensive income shows a figure for revenue earned from selling goods to customers. This is the total amount of revenue earned from all the individual sales made during the period. One of the jobs of an accountant is to devise methods of recording such individual transactions, so as to produce summarised financial statements from them.
The statement of financial position and the statement of comprehensive income form the basis of the financial statements of most businesses. For limited liability companies, other information by way of statements and notes may be required by national legislation and / or accounting standards, for example a statement of cash flows.
Question 2: Accounting information
The financial statements of a limited liability company will consist solely of the statement of financial position and statement of comprehensive income.
Is this statement correct?
A true
B false (The answer is at the end of the chapter)
Key chapter points
x Transactions and other events are grouped together in broad classes and in this way their financial effects are shown in the financial statements. These broad classes are the elements of financial statements.
x Financial position is shown by:
– Assets
– Liabilities
– Equity.
x Financial performance is shown by:
– Income
– Expenses.
x Items which meet the definition of assets or liabilities may still not be recognised in financial statements because they must also meet certain recognition criteria.
x The principal financial statements of a business are the statement of financial position and the statement of comprehensive income.
Quick revision questions
1 Of what is the following statement a definition?
'A resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.'
A equity B liability C asset D expense
2 Which of the following is the correct definition of a liability?
A the residual interest in the assets of the entity after deducting all its liabilities
B a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits
C a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity
D a present obligation arising from past events from which future economic benefits are expected to flow to the entity
3 What are the criteria for recognition of items in the financial statements according to the IASB’s Framework?
A probable that future economic benefit will flow to or from the entity
B probable that future economic benefit will flow to or from the entity and the item can be measured with reliability
C probable that there will be outflow of future economic benefits and there is a past transaction D probable that there will be an inflow or outflow of future economic benefits and there is a
past transaction
4 What items are recognised in the statement of comprehensive income?
I Assets
5 Which of the following is an example of a current asset?
A property, plant and equipment B motor vehicles held for sale C manufacturing licences D retained earnings
6 Which of the following items are non-current assets?
I Land II Machinery III Bank loan IV Inventory A I only B I and II only C I, II and III D II, III and IV
7 How is a bank overdraft classified in the statement of financial position?
A non-current asset B current asset C current liability D non-current liability
8 How should the balance on the payables account be reported in the final accounts?
A as an expense B as a current asset C as a current liability D as a non-current asset
9 Which of the following is an example of a liability?
A inventory B receivables
C plant and machinery D loan
10 What determines whether an asset should be shown as a current asset in the statement of financial position?
A whether it is part of the operating cycle of the entity and this provides more relevant and reliable information
B whether it is used on a long term basis in the business
Answers to quick revision questions
The answers to these quick revision questions can be found in the Answers to quick revision questions at the end of the Study Manual.
Self-assessment questions
1 Which of the following is the correct definition of equity?
A the residual interest in the assets of the entity after deducting all its liabilities
B a present obligation arising from past events, the settlement of which is expected to result in an outflow of resources embodying economic benefits
C a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity
D a present obligation arising from past events from which future economic benefits are expected to flow to the entity
2 Consider the following statements:
I A provision is a liability for which the amount is an estimate II A provision should not be recognised in the financial statements Which of the statements are correct?
A I only B II only
C both statements D neither statement
3 Consider the following statements:
I Gains from the sale of non-current assets are unrealised gains II Gains from revaluation of non-current assets are realised gains Which of the statements is correct?
A I only B II only
C both statements D neither statement
4 What is the definition of materiality?
A information which will be of particular significance to the managers of a business B information which will be of particular significance to the owners of a business
C information whose omission or misstatement could influence the economic decisions of users of the financial statements.
D information which has a large monetary value compared to the revenue of the business 5 Which of the following would be included in the working capital of a business?
A receivables, bank loan, payables, inventory B payables, receivables, inventory, cash at bank C inventory, equity, cash at bank, receivables D inventory, bank loan, cash at bank, prepayments
6 Which of the following would appear in the statement of financial position as a current liability?
A prepayments of expenses B employee wages
C sales tax owing
D revaluation surplus on a non-current asset
Answers to self-assessment questions
The answers to these self-assessment questions can be found in the Answers to self-assessment questions at the end of the Study Manual.
Answers to chapter questions
1 (a) This is an asset, albeit an intangible one. There is a past event, control and future economic benefit (through cost savings).
(b) This cannot be classified as an asset. Baldwin Co has no control over the car repair shop and it is difficult to argue that there are 'future economic benefits'.
(c) The warranty claims in total constitute a liability; the business has taken on an obligation. It would be recognised when the warranty is issued rather than when a claim is made.
2 B Notes to the statements of financial position and comprehensive income form part of the financial statements, and other statements, such as a statement of cash flows, are usually needed.
Learning objectives Reference
Alternative methods of valuation LO6
Identify the advantages and disadvantages of the historical cost system of accounting
LO6.1
Identify, explain and calculate amounts using the following measurement
bases: LO6.2
historical cost LO6.2.1
current cost LO6.2.2
fair value LO6.2.3
deprival value LO6.2.4
replacement cost LO6.2.5
net realisable value LO6.2.6