Limitations of the statement of financial position

Preparing a statement of financial position

At the end of each accounting period a trial balance is prepared, which is a list af all the balances in the accounting records of the business. A trial balance is used to check that the double-entry bookkeeping has been carried out accurately.

The following steps can be used when preparing a statement of financial position:

1. Start by writing the title, stating the name of the individual the statement of financial position as at the relevant date.

2. Then you need to list the assets.

3. Next list the current assets in order of liquidity, total then and add them to the total for the non-current assets. This gives the total assets figure. Double-underline this as it is the end of the first part of the statement of financial position.

4. Then show the capital.

5. Next show the liabilities, starting with the current liabilities which you need to list and total.

6. Then list the non-current liabilities. Total them and add them to the total of the current liabilities. This gives you the total liabilities figure.

7. If the total assets do not equal the total of the capital plus the liabilities, the SoPF does not balance and therefore you must have made a mistake. At the point, you need to go back through your work and find out where you have gone wrong.

Opening balance shows the capital that had been invested in the business at the start of the accounting period; this will be the same as the closing balance on the capital account at the end of the previous accounting period.

Capital introduces shows the value of all assets the owner has invested in the business during the accounting period. This is likely to be in the form of cash but may include an asset such as a motor vehicle. If there is sufficient capital in the business the owner may not need to introduce any more during the accounting period and, therefore, in some examples there will be no capital introduced.

Drawings show the value of any assets that the owner has taken out of the business during the accounting period, which is usually in the form of cash.

Reflective question

3. Which of the following assets are current assets?

· Inventory

· Offices

· Office furniture

· Current account at bank

· Account receivable

· Vans

· Machinery

· Cash kept in a tin

· Factory

Published statements of financial position

In the real world you may come across the financial statements of a public limited company (plc) that is quoted on a stock exchange. The financial statements of these quoted companies are governed by an International Accounting Standard IAS 1 Presentation of Financial Statements. The non-quoted companies we have been dealing with above have the option to adopt this international accounting standard but a present few are choosing to do this.

Limitations of the statement of financial position

The statement of financial position is a useful document that aids decision-making and summarizes the position of the business to enable users to assess its performance. However, if you were going to buy a business, you would not base your decision solely on the information contained in the statement of financial position, as a statement of financial position does have its limitations:

· The statements of financial position only contains numerical data and is purely a summary of the financial position of the business. It does not include non-numerical information such as the quality of the staff, levels of customer satisfaction, business location, local competition or the economic conditions at the time the statement of financial position was prepared.

· The statement financial position is produced on a given day of the year, which provides the opportunity for a business to manipulate the information to present a better picture. Potentially, if the statement of financial position was prepared not long before or not long after a different picture could be presented.

· The statement of financial position is based upon historical cost, which may not represent the income that could be raised if a particular asset was sold, for instance, property is valued at cost and may therefore be shown in the statement of financial position at below market value.

· A time period elapses between the statement of financial position date and the time the information becomes available. Consequently, the information is often out of date before it becomes available and therefore may not be very useful in helping to predict the future.

· Personal opinions and judgements are used in calculating the statement of financial position values of some of the assets. You will consider the use of these personal judgements in the calculation of depreciation and provisions later in this book.

Review questions

1. How would you define the following terms?

a) non-current assets

b) current liabilities

c) accounts receivable

d) accounts payable

6. David prepared the following trial balance from his accounting records for his carpentry business on 31 march 2011. You are required to prepare a statement of financial position as at that date.

Freehold premises	60,000
Inventory	5,000
Accounts receivable	3,000
Accounts payable		2,500
Bank balance	1,000
Motor vehicles	7,000
Capital		73,500
	76,000	76,000

8. The accountant of Cubert Ltd produced the following trial balance as at 31 October 2005:

Freehold land and buildings	168,000
Ordinary shares at £1 each		6,000
Plant and equipment	22,000
Trade receivables	3,700
Motor vehicles	18,000
Inventory	21,600
Bank overdraft		6,500
Bank loan (repayable 2009)		80,000
Bank loan (repayable 2005)		4,600
Trade payables		1,100
Share premium account
Retained earnings		127,800
Corporation tax owing		1,300
Short-term provisions		5,400
	233,300	233,300

You are required to produce a statement of financial position for Cubert Ltd as at October 2005.

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