Statement of financial position
\text{Assets} = \text{Liabilities} + \text{Equity}
To understand this statement, you must classify every item into one of three main sections:
- Non-current assets: Long-term resources.
- Current assets and Current liabilities: Short-term resources and obligations (within 12 months).
- Equity: The owner's residual interest.
Understanding these classifications is essential because the examiners test your ability to identify where specific items belong based on their nature and timing.
Assets are resources owned or controlled by the business that are expected to bring future economic benefits.
They are classified into two types based on how long they will be used:
- Non-current assets: Resources held for use over a period longer than one year. They are not intended for immediate sale.
- Current assets: Resources owned by the business that are expected to be converted into cash, sold, or consumed within one year (or the normal operating cycle) of the reporting date.
Liabilities are present obligations of the business arising from past events, the settlement of which is expected to result in an outflow of resources.
Like assets, they are classified by timing:
- Non-current liabilities: Debts or obligations that are not due for payment within one year from the reporting date.
- Current liabilities: Obligations that must be settled (paid) within one year (or the normal operating cycle) of the reporting date.
Equity (also called Net Assets or Owner's Equity) represents the residual interest in the assets of the entity after deducting all its liabilities.
\text{Equity} = \text{Total Assets} - \text{Total Liabilities}
It reflects what the owners have invested in the business and the profits retained within it. It is not a debt owed to outsiders, but rather the owners' claim on the business's assets.
Examples of Equity items:
- Share Capital: Money invested by shareholders in exchange for ownership shares (for limited companies).
- Retained Earnings: Profits made by the business that have not been distributed to owners as dividends but are kept within the business for future use.
- Capital Account: The account showing the owner's investment and drawings for a sole trader.
| Reasoning |
|---|
| Used in operations for more than one year. |
| Held for sale and expected to be converted to cash within one year. |
| Money owed by customers, typically collected within 30-90 days. |
| A short-term loan from the bank repayable on demand or within one year. |
| Money owed to suppliers, typically paid within 30-90 days. |
| The repayment period is longer than one year from the reporting date. |
| Represents the owners' investment; not a debt to outsiders. |
Students often write 'Assets are owed to others.' This is incorrect. Liabilities are amounts owed to others (outsiders). Assets are resources owned by the business.
Mistake 2: Ignoring the 12-Month Rule for Liabilities
When classifying a loan, students often forget to check the repayment date. A bank loan is only a Non-current Liability if the repayment is due after one year from the statement date. If any part of the loan is due within 12 months, that portion must be classified as a Current Liability. Always look for the phrase 'due within 12 months' in the question data.
When to use this tip: When asked to define 'Current Assets' or 'Non-current Assets' in a short-answer question.
Why examiners accept this: The markscheme requires specific keywords related to time and ownership. Vague answers like 'things the business has' will not gain full marks.
Correct Usage Example:
- Question: Define non-current assets.
- Acceptable Answer: 'Resources owned by a business which will be used for a period longer than one year.'
- Key Phrase to Include: You must explicitly state 'longer than one year' (or 'more than 12 months') and 'owned by the business'. Without the time element, the definition is incomplete.