Chapter 2

• A statement of financial position is a formal statement showing the three elements comprising financial position, namely assets, liabilities and equity.
• Liquidity is the ability of the entity to meet currently maturing obligations
• Solvency is the availability of cash over the longer term to meet maturing obligations.
• Information about liquidity and solvency is useful in predicting the ability of the entity to comply with future financial commitments and to pay dividends to shareholders
• PAS 1, paragraph 60, provides that an entity shall present current and noncurrent assets, and current and noncurrent liabilities, as separate classifications in the statement of financial position.
• The Revised Conceptual Framework defines an asset as a present economic resource controlled by the entity as a result of past events.
• An economic resource is a right that has the potential to produce economic benefits.
• The essential characteristics of an asset are:

  1. The asset is controlled by the entity.

  b. The asset is the result of a past event.

  c. The asset has the potential to produce economic benefits.
• PAS 1, paragraph 66, provides that an entity shall classify an asset as current when:

  1. The asset is cash or a cash equivalent unless the asset is restricted to settle a liability for more than twelve months after the reporting period.

  2. The entity holds the asset primarily for the purpose of trading.

  3. The entity expects to realize the asset within twelve months after the reporting period.

  4. The entity expects to realize the asset or intends to sell or consume it within the entity's normal operating cycle.
• The cash and cash equivalent shall be unrestricted in use, meaning available anytime for the payment of current obligations.
• PAS 7, paragraph 6, defines cash equivalents as short-term, highly liquid investments that are readily convertible into known amount of cash and which are subject to an insignificant risk of changes in value.
• An investment normally qualifies as a cash equivalent only when it has a short maturity of three months or less from the date of acquisition.
• Equity securities cannot qualify as cash equivalent because shares do not have a date of maturity.
• Financial assets held for trading are debt and equity securities that are purchased with the intent of selling them in the "near term" or very soon in order to generate short-term gain.
• Nontrade receivables represent claims arising from sources other than the sale of merchandise or services in the ordinary course of business.
• Nontrade receivables are classified as current assets if collectible within one year from the end of reporting period, the length of the operating cycle notwithstanding.
• The operating cycle of an entity is the time between the acquisition of assets for processing and their realization in cash or cash equivalents.
• When the normal operating cycle is not clearly identifiable, the duration is assumed to be twelve months.
• The operating cycle of a trading entity is the average period of time that it takes to acquire the merchandise inventory, sell the inventory to customers and ultimately collect cash from the sale.
• The operating cycle of a manufacturing entity is defined as the period of time between acquisition of materials entering into a process and their realization in cash or an instrument that is readily convertible into cash.
• The normal operating cycle is significant as it is the basis of determining the proper classification of assets into either current or noncurrent.
• Current assets are usually listed in the statement of financial position in the order of liquidity
• Deferred tax asset is classified as noncurrent asset.
• Property, plant and equipment as tangible assets which are held by an entity for use in production or supply of goods and services, for rental to others, or for administrative purposes, and are expected to be used during more than one period.
• The major characteristics of the definition of property, plant and equipment are:

  1. The property, plant and equipment are tangible assets, meaning with physical substance.

  b. The property, plant and equipment are used in business, meaning used in production or supply of goods and services, for rental purposes and for administrative purposes.

  c. The property, plant and equipment are expected to be used over a period of more than one year.
• Investment as an asset held by an entity for the accretion of wealth through capital distribution, such as interest, royalties, dividends and rentals, for capital appreciation or for other benefits to the investing entity such as those obtained through trading relationship.
• A current investment is an investment that is by nature readily realizable and is intended to be held for not more than one year.
• A noncurrent or long-term investment is an investment other than a current investment or investment intended to be held for more than one year.
• Intangible asset is an identifiable nonmonetary asset without physical substance.
• An intangible asset is identifiable:

  1. When it is separable or capable of being sold, transferred, licensed, rented or exchanged separate from the entity.

  b. When it arises from contractual or other legal right.
• Liability is defined as a present obligation of an entity to transfer economic resource as a result of past events.
• The essential characteristics of a liability are:

  1. The entity has a present obligation.
  2. The obligation is to transfer an economic resource.
  3. The liability arises from past event.
• PAS 1, paragraph 69 as amended, provides that an entity shall classify a liability as current when:

  1. The entity expects to settle the liability within the entity's normal operating cycle.

  2. The entity holds the liability primarily for the purpose of trading.

  3. The liability is due to be settled within twelve months after the reporting period.

  4. The entity does not have the right at the end of reporting period to defer settlement of the liability for at least twelve months after the reporting period.
• PAS 1, paragraph 72, provides that a liability which is due to be settled within twelve months after the end of reporting period is classified as current, even if:

  1. The original term was for a period longer than twelve months.

  b. An agreement to refinance or to reschedule payment on a long-term basis is completed after the end of reporting period and before the financial statements are authorized for issue.
• However, if the refinancing on a long-term basis is completed on or before the end of the reporting period, the refinancing is an adjusting event and therefore the obligation is classified as noncurrent.
• Covenants are often attached to borrowing agreements which represent undertakings by the borrower.
• These covenants are actually restrictions on the borrower as to undertaking further borrowings, paying dividends, maintaining specified level of working capital and so forth.
• Under these covenants, if certain conditions relating to the borrower's financial situation are breached, the liability becomes payable on demand.
• However, Paragraph 75 states that the liability is classified as noncurrent if the lender has agreed on or before the end of reporting period to provide a grace period ending at least twelve months after the end of reporting period.
• The grace period is a period within which the borrower can rectify the breach and during which the lender cannot demand immediate payment.