Statement of Financial Position: Company Assets and Liabilities

The statement of financial position, also known as the balance sheet, is one of the most important financial statements that provides a snapshot of an entity’s financial position at a specific point in time. The statement of financial position shows what the entity owns (assets) and what it owes (liabilities), as well as the owners’ equity (equity). In this article, we will explain the statement of financial position in detail, discuss its main components of assets, liabilities, and equity, clarify how to prepare and analyze it, and highlight its importance to users of financial statements in assessing an entity’s financial position.

What is the Statement of Financial Position?

The statement of financial position is a financial report that summarizes an entity’s assets (its economic resources), liabilities (its financial obligations), and equity (owners’ investments and retained earnings) at a specific date, usually the end of the financial period. The statement of financial position provides a comprehensive view of the entity’s financial position at that moment, and helps in assessing its liquidity, solvency, and financial structure.

Importance of the Statement of Financial Position:

The importance of the statement of financial position lies in its being:

• A Tool for Assessing Financial Position: The statement of financial position helps assess the entity’s financial position in terms of its liquidity (ability to meet short-term obligations), solvency (ability to meet long-term obligations), and financial structure (sources of financing its assets).
• A Basis for Decision-Making: The statement of financial position provides essential information for making investment, financing, and management decisions by investors, creditors, and management.
• A Tool for Forecasting Future Performance: Information from the statement of financial position, along with information from other financial statements, can be used to forecast the entity’s future performance.
• A Means of Communication with External Parties: The statement of financial position is an effective way to communicate financial information to external parties, such as investors, creditors, and government agencies.
• A Tool for Monitoring and Accountability: The statement of financial position is used to monitor management’s performance and hold them accountable for managing the entity’s assets and liabilities.
• A Basis for Legal Compliance: Many laws and regulations require companies to prepare and disclose financial statements, including the statement of financial position.

Types of Financial Statements: The main Financial Statements, according to International Financial Reporting Standards (IFRS) include:

• Statement of Financial Position:
  • Also called the balance sheet.
  • it presents the assets, liabilities, and equities of the company on a specific date (usually the end of a financial period).
  • it shows the basic accounting equation: Assets = Liabilities + Equity.
  • This part of the definition of financial statements provides a quick look at the entity’s Financial standing at a specific moment in time.
• Income Statement:
  • Also known as the statement of profit or loss.
  • it presents the revenues, expenses, and net profit or loss for a given period (usually a fiscal year).
  • It shows the economic activity outcome of the entity within the specified period.
• Statement of Comprehensive Income:
  • it presents the changes in equity that do not result from transactions with equity owners, like the profit or loss from asset revaluation, and foreign currency translation differences.
  • It can be presented as a seperate statement, or as a part of the income statement.
• Statement of Changes in Equity:
  • it presents the changes that occur in the entity’s equity within the fiscal period, like the issuance of new shares, dividend distributions, net profit or loss, and the effect of changes in Accounting Policies.
• Statement of Cash Flows:
  • Displays the movement of incoming and outgoing cash within the company during a financial period.
  • Classifies cash flows into three main activities: operating, investing, and financing.
  • Helps in evaluating the company’s ability to generate cash and pay its obligations.
• Notes to the Financial Statements:
  • Provide an explanation of the significant Accounting Policies used in preparing the Financial Statements.
  • Provide additional information about the items in the Financial Statements.
  • Disclose any other information necessary to understand the Financial Statements.
  • Are considered an integral part of the Financial Statements.

Components of the Statement of Financial Position:

The statement of financial position consists of three main elements:

1. Assets:
   • Definition: Economic resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.  
   • Classification of Assets:
     • Current Assets: Assets that are expected to be converted into cash or used within one year or one operating cycle, whichever is longer. They include:
       • Cash and Cash Equivalents: Includes cash on hand, cash in banks, and highly liquid short-term investments.
       • Accounts Receivable: Amounts owed to the entity by customers for the sale of goods or services.
       • Inventory: Goods held for sale or raw materials used in production.
       • Prepaid Expenses: Expenses that have been paid in advance but the service has not yet been used, such as prepaid rent.
       • Short-term Financial Investments: Investments in financial instruments that are expected to be converted into cash within a short period.
     • Non-current Assets: Assets that are expected to be used for more than one year. They include:
       • Property, Plant and Equipment (PP&E): Tangible assets used in the entity’s operations, such as land, buildings, machinery, equipment, and vehicles.
       • Investment Property: Real estate (land or buildings) held to earn rental income or for capital appreciation, or both.
       • Intangible Assets: Non-physical assets that have economic value, such as patents, trademarks, and goodwill.
       • Long-term Investments: Investments in financial instruments that are expected to be held for more than one year.
       • Deferred Tax Assets: Arising from temporary differences between accounting profit and taxable profit.
2. Liabilities:
   • Definition: Present obligations of the entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity.  
   • Classification of Liabilities:
     • Current Liabilities: Obligations that are expected to be settled within one year or one operating cycle, whichever is longer. They include:
       • Accounts Payable: Amounts owed to suppliers for the purchase of goods or services.
       • Short-term Loans: Loans that are due within one year.
       • Accrued Expenses: Expenses that have been incurred but not yet paid, such as accrued salaries.
       • Unearned Revenue: Amounts collected in advance from customers for goods or services that have not yet been provided.
     • Non-current Liabilities: Obligations that are expected to be settled after more than one year. They include:
       • Long-term Loans: Loans that are due over more than one year.
       • Bonds: Long-term debt instruments issued by the entity to finance its operations.
       • Deferred Tax Liabilities: Arising from temporary differences between accounting profit and taxable profit.
       • Long-term employee benefits obligations, such as pension plan obligations.
3. Equity:
   • Definition: The residual interest in the assets of the entity after deducting its liabilities. Equity represents the owners’ investments in the entity plus retained earnings.
   • Components of Equity:
     • Capital: Amounts invested by the owners in the entity.
     • Reserves: Retained earnings for specific purposes, such as a legal reserve or expansion reserve.
     • Retained Earnings: Accumulated profits that have not been distributed to shareholders.
     • Additional paid-in capital: The difference between the nominal value of a stock and its sale price.

The Accounting Equation:

The accounting equation is the foundation of the statement of financial position, and it states that:

Assets = Liabilities + Equity

This equation reflects the fact that an entity’s assets are financed either through liabilities (debt) or through equity (owners’ investments and retained earnings).

Steps for Preparing the Statement of Financial Position:

1. Determine the Reporting Date: The statement of financial position is usually prepared at the end of the financial period (e.g., at the end of the fiscal year).
2. Gather Financial Data: The necessary financial data is gathered from the ledger, including the balances of all asset, liability, and equity accounts.
3. Classify Assets and Liabilities: Assets and liabilities are classified into current and non-current.
4. Arrange Items: Items of assets, liabilities, and equity are arranged in a specific order (as shown below).
5. Calculate Totals: The total of each of current assets, non-current assets, and total assets is calculated. The total of each of current liabilities, non-current liabilities, and total liabilities is also calculated. Finally, total equity is calculated.
6. Verify the Accounting Equation: It must be ensured that total assets equal total liabilities and equity.

Format of the Statement of Financial Position:

The statement of financial position can be presented in two main formats:

1. Report Form:
   • Assets are presented first, followed by liabilities, and then equity in a vertical list format.
2. Account Form:
   • Assets are presented on the right side, and liabilities and equity are presented on the left side, in a “T” shape.

Example of a Statement of Financial Position (Report Form):

Company __________ Statement of Financial Position as of December 31, 2023

Note: Retained earnings at the end of 2023 are calculated adding 2023 Net profit (75,000) to the retained earnings at the beginning of the year.

Error: It is clear when reviewing the statement of financial position that there is a data entry error. Total Assets do not equal Total Liabilities and Equity. This indicates a data entry error, and so the definition of financial statements and the steps to prepare them, should be reviewed.

Correction: After reviewing the entered data, it was found that the value entered for Equity was incorrect. it should be as follows:

| Equity: | | | ——————————————– | ————— | | Capital | 100,000 | | Retained Earnings (55,000 + 75,000) | 130,000 | | Total Equity |230,000 | | Total Liabilities and Equity | 355,000 |

Analysis of the Statement of Financial Position:

The statement of financial position can be analyzed through:

• Horizontal Analysis: Comparing items in the statement of financial position across different time periods to identify trends in changes in the entity’s assets, liabilities, and equity.
• Vertical Analysis: Expressing each item in the statement of financial position as a percentage of total assets or total liabilities and equity.
• Ratio Analysis: Calculating and using financial ratios derived from the statement of financial position to assess the entity’s liquidity, solvency, and financial structure.

Key financial ratios derived from the statement of financial position:

• Current Ratio: Measures the entity’s ability to meet its short-term obligations. Current Ratio = Current Assets / Current Liabilities.
• Quick Ratio (Acid-Test Ratio): A more conservative measure of liquidity than the current ratio, as it excludes inventory from current assets. Quick Ratio = (Current Assets – Inventory) / Current Liabilities.
• Debt-to-Equity Ratio: Measures the extent to which the entity relies on debt to finance its assets. Debt-to-Equity Ratio = Total Liabilities / Total Equity.
• Fixed Asset Coverage Ratio: Measures the adequacy of fixed assets to cover long-term liabilities. Fixed Asset Coverage Ratio = Net Fixed Assets / Long-term Liabilities.

Role of Technology in Preparing the Statement of Financial Position:

Accounting software and Enterprise Resource Planning (ERP) systems help automate the process of preparing the statement of financial position, leading to:

• Increased speed and efficiency of financial reporting.
• Reduced human errors in recording and posting entries.
• Improved accuracy of financial data.
• Saving time and effort.
• Generation of various financial reports and advanced financial analyses.

Disclosures related to the statement of financial position Additional information must be disclosed within the notes regarding the items presented in the statement of financial position, such as:

• The applied accounting policies when preparing the statement of financial position.
• Details about the components of assets, liabilities, and equity.
• Information regarding the assets and liabilities measured using fair value.
• Information about assets pledged as security for liabilities.
• Information about potential liabilities and commitments.

Conclusion:

The statement of financial position is a fundamental tool for understanding an entity’s financial position at a specific point in time. This statement provides valuable information about the entity’s assets, liabilities, and equity, helping users of financial statements assess the entity’s liquidity, solvency, and financial structure.

Understanding the definition of financial statements, their components, and how to prepare and analyze them is essential for all stakeholders, including investors, creditors, management, and employees. Mastering the steps of the financial statement preparation process enhances your skills in financial accounting and helps you succeed in the world of finance and business. Finally, technological developments facilitate the preparation of the statement of financial position and improve the quality and accuracy of the financial information provided. Remember that financial statements are not just static numbers; they are a reflection of the entity’s story and performance, and understanding this story helps you make more informed decisions.