The Balance Sheet
FCA FCCA MBA
4 Fundamental Accounting
Going Concern - That the business will
continue and not be liquidated.
Accruals (or Matching) - That income is
matched with expenditure. You match the sale
with the cost of that sale.
Consistency - What you did last year you do
this. Otherwise figures would be meaningless.
Prudence - Caution is essential. Note
“Prudence must prevail”
What is a Balance Sheet
It is like a photograph taken on a given date
of the financial position of the company.
What is a Balance Sheet
Need Picture of assets
liabilities and equity
The Accounting Equation
The Assets = Liabilities + Shareholders ( Owners)Equity.
Assets = Liabilities
A Balance Sheet…..
Non Current Non Current
Intangibles Shareholders Equity
Has a present or future economic value.
It MUST be worth something. If NOT it is
NOT an asset
There are 4 basic categories of Assets.
Non Current Assets
Current Assets - Those that are used for the day
to day trading of the company and are expected
to be consumed within 12 months.
E.g.: Accounts Receivable and Inventories.
Current Assets Should be...
Expected to be realised, consumed, sold or
settled within 12 months.
Held primarily for trading purposes or short
Is Cash or Cash Equivalents which are not
Bank Balances and Cash
Cash or Cash Equivalents
If a bank account is held and there is a
positive balance then this is treated as a
If it is negative it is a current liability.
Cash Equivalents means investments
immediately convertible into cash such as a
bank deposit account.
Very Short Term and highly liquidable
Accounts Receivable ( DEBTORS)
A firm often sells goods where the buyer pays
for them some time later. The firm has to
recognise that it has sold something but as
yet not been paid for it.
This therefore represents an asset of the firm
being money that it will receive from the sale
of goods or services that it has already made.
Note that any of these that are likely to fail to
pay, should be deducted and recognised as a
bad debt in the Income Statement.
Money due from customers.
Sometimes called Debtors.
Bad Debts are those that are unlikely to be
Inventories ( Stocks & WIP)
Companies that manufacture goods or buy
and sell will normally have to acquire the
goods to be sold before selling them. They
normally hold these until a customers
acquires them. These goods are called
inventories or stocks.
There are several different classes of
Inventories based on the state of the goods.
3 Classes of Inventories
Raw Materials - The basic materials before
Work in Progress - where goods are being
converted to finished items.
Finished Goods - Items ready for sale.
Valuation of Inventories
The lower of Cost or Net realisable value.
Must adjust for any further costs required to
enable these to be sold.
For example. A car dealer has a new BMW in
stock. It cost €20,000. However it is now
only worth €18,000 and requires €800 to be
spent on it to enable it to be sold. Inventory
value = 18,000 – 800 = 17,200.
Slow Moving or Obsolete
Must adjust for these
LIFO vs FIFO
Last In First Out is where you account for
stocks on the basis that the last item acquired
is the first item out. This tends to under value
the stocks as it means that the remaining
stocks are the oldest which probably costs less
First In First Out is where you expect to
consume the oldest items first. This is now
generally accepted as more reasonable but the
USA still use LIFO.
LIFO vs FIFO
FIFO now the only accepted method under
These represent items which have been paid
in an accounting period but at the Balance
Sheet date, have not been fully consumed.
Here the Accruals(Matching) concept requires
us to recognise this.
Example: The company pays its 12 months
vehicle insurance one month before the year
end. You would accept to charge one month
in the Revenue Statement and take 11
months in The Balance Sheet so as to match
against next years income.
A Company pays its annual insurance for the 12
months from 1st December 2006 of £12,000. At
the 31st December, it has only consumed 1/12
of this expenditure. The matching concept
requires to match 1/12 in the closed year and to
take the remaining 11/12 forward to match it
against the next year. These non-consumed
expenditures are classified as prepayments in
Current Assets in the Balance Sheet.
Non Current Assets NCA’s
Those that are held to enable the company to
function. E.g. Plant and Equipment vehicles and
NCA’s lose value as they are used. This loss
in value is called depreciation. (We will return
to this later)
NCA’s Intangible Assets
Like Goodwill, know how, trade marks & Patents.
( we will deal with later)
Have value but value can be easily lost.
Should be written off as quickly as possible.
A company may acquire shares in other
companies. These will represent assets and
be shown in the Balance Sheet as
Investments. Normally held for a long time.
Short Term Investments in say Government
Stocks can be shown as Current Assets so
long as they can be easily converted into
Accounting For Leased Assets
Financing Lease - Essentially a way of buying
the asset. Substance over legal form.
Operating Lease - Just a daily or weekly hire.
Some leased assets are essentially a loan
and in real terms the asset is under the
ownership of the lessee ( The person who
uses the asset) These are called Financing
Leases and should recognise the real
issues… ie “substance over legal form”
Finance leases should be capitalised.
Operating leases are basic, normally short
term, rental agreements. They should not be
Treated as if it had been bought by the
The asset is shown in the Balance Sheet
along with the total commitments outstanding
to the leasing Company
Represent an obligation of the business
arising from past events. The settlement of
this is expected to result in an outflow from
the recourses of the business having itself
created economic benefit.
It we are never going to write out a cheque
then it is not a liability.
A liability is what its name says. It is a
responsibility of the enterprise and is some
form of debt. There are 2 essential
categories of these.
Current Liabilities -
Non Current Liabilities -
Those that are to be settled within 12 months.
Current Proportion of Long Term Loans
Accounts Payable (Creditors)
Most companies buy materials and supplies
on credit paying for them weeks or even
months later. Thus the accounts must show
that there is a liability outstanding when the
goods are received / Invoiced, until they are
actually paid for.
The amount that is due to be paid as
dividends to shareholders.
Current Tax payable to the government.
Tax & Deferred Tax
Tax is divided into two categories. Tax that
has to be paid to the government and tax that
is delayed due to certain concessions or tax
Tax that is payable to the government is
shown as a current liabilities as this will have
to be paid quickly.
Deferred tax is a Non Current Liability as it is
not payable for at least 12 months.
Tax that is not payable within 12 months.
Extract Income Statement
EBIT 650,000 575,000
Deduct: Interest 60,000 50,000
Profit Before Tax 590,000 525,000
Deduct: Taxation at 40% (See Note 23) 236,000 210,000
Deduct: Dividends 100,000 90,000
Retained Reserves For Year 136,000 120,000
Note to The accounts No 23.
Mainstream Tax Liability 156,000 180,000
Deferred Taxation 80,000 30,000
Total Tax Provision 236,000 210,000
In order to comply with the Matching
Concept, it is necessary to make adjustments
for items that have yet to be invoiced but are
due and need to be matched with the year or
accounting period to which they relate.
Example: A company receives its 3 month
telephone bill one week after the year end.
The whole bill relates to the closed year.
This would need to shown as an Accrual.
Non Current Liabilities
Those that are due to be settled after one year.
Loans with maturity more than 12 months
Long Term Loans
Loans repayable more than 12 months away
are treated as Non Current Liabilities. Any
portion repayable within 12 months will be
shown as a current liability.
Proportion of Loans repayable
within 12 months
A Company has a bank loan of $90k
repayable over the next 9 years by equal
installments of $10k. Thus in Current
Liabilities would be $10k and in Non Current
Liabilities would be $80k.
Current & Non Current
Loan of €90,000 Repayable over 9 years by
Current Non Current Laibility
Dividends which are due and payable within 12
moths are normally shown separately under
More than 50% likely we will have to write out a
Must show as a liability in the Balance Sheet.
Bad Debts (Accounts Receivable that might well not
Proposed Management Bonuses or Audit Fees.
Litigation where the outcome is likely to be adverse..
Possible obligation from past events not
within the companies control.
The present obligation may not have any
financial effect or as yet not determinable.
If a contingency is more that 50% likely to
happen then it is a provision and needs to be
included in the Balance Sheet.
Contingencies - Accounting
Should be disclosed in a note to the
A description given even in the notes.
Reasons for any uncertainty.
Attempt to quantify.
Most companies separate these out.
If still there then should show as Non Current
Liability except the amounts payable to
retired staff within next 12 months which are
shown as Current Liabilities.
Limited Liability Companies require investors to
provide capital. Initially in the form of shares
and then by leaving their profits in the firm.
( Called retained earnings)
Share Capital & Reserves
The companies capital structure is initially
written down in its foundation documents
called Memorandum & Articles of
Different Types of Shares
Common or Ordinary Shares - These are the
real owners of the company ( Once you have
50% plus you own and control the company)
Preference Shares - Basically a loan.
Normally no voting rights.
Authorised, Issued and Paid up
Authorised is the number and amount that
the Memorandum permits. This can be
changed upwards, normally by application to
Issued is the number of shares actually
Paid up is the number actually paid for.
Difference is that sometimes shares can
The company will not normally pay all its profits
to the shareholders as dividends. They will
retain some to fund the activities and growth
of the business. There profits not distributed
are called “Retained Earnings”.
Shares sold by the company at a premium.
The premium is collected here.
Where shares are say $1 each, often a
company will sell them for say $1.50 or more.
This premium is shown as a separate item in
the Shareholders Equity.
NCA’s can be revalued.
If they are, the increase should be recorded
Note that under IFRS these reserves cannot
be distributed as dividends.
These are revaluation reserves generated by
re-valuing a Non Current Asset or the
disposal of a Non Current Asset.
Shares that the company has bought back.
Many issues over how to show these in the
After Balance Sheet Events
Activities occurring after the Balance Sheet
date may or may not require adjustment or a
note. Such events may be favourable or not.
Either provide evidence of conditions that
existed at the Balance Sheet date or
indicate conditions that occurred after the
Balance Sheet date but make a material
effect to the possible future outcome.
Off Balance Sheet Finance
Sale and lease back of a Fixed Asset along
with its associated borrowings to a Special
Purpose Vehicle (SPV) e.g.Enron!!!
Buying loss making companies via a SPV
until they become profitable.
This represents manipulating the figures for a
Example: a company may try to improve the
picture so as to inflate share price or gain
beneficial loan arrangements. Alternatively, if
tax was high, then possibly reducing profits
so as to pay less tax. Often such
adjustments are done at the year end by
issuing invoices early or delaying until the
next year. 71
Balance Sheet as at 31st May 2006
Current Assets Current Liabilities
Accounts Receivable 200,000 Accounts Payable 150,000
Inventories 150,000 Tax Payable 50,000
Bank Balance 125,000 Current Proportion of Loan 25,000
Total Current Assets 475,000 Total Current Liabilities 225,000
Non Current Assets Non Current Liabilities
Plant & Equipment 100,000 Bank Loan 250,000
Less: Depreciation -50,000
Total Non Current Assets 50,000 Shareholders Equity
Investments 25,000 Retained Earnings 50,000
Total Shareholders Equity 75,000
Total Assets 550,000 Total Liabs & Equity 550,000 73
Consolidated Balance Sheet
Where you have a group of Companies, the
parent will consolidate its subsidiaries into its
It will add all the groups assets and liabilities
Minority Interest is the % that is not owned by
Lets work this together
Prepare for next class
Exercise 3. We will work this together when
we next meet.
Group Study Research
You should each look at 2 companies and evaluate for
qualitative purposes. (See end of Chapter 6) This
should include the following:
Corporate Social Responsibility
Transparency and clarity of the company financial information
Strategy – clear sustainable and achievable
Readability of the reported information
Additional shareholder tools and reports.
Group Study Research
Once you have reviewed these 2 companies each,
you should aim to eliminate one on the grounds
that it fails for certain reasons against benchmarks
that you have set. ( See end of chapter 6).
Then as a group you should evaluate these
companies preparing a 30-40 minute presentation
which will be made on the final session at the end
of this course.
to be continued…..