Module 02 Notes
Module 02 Notes
Financial position of a firm – what the resources the business has and how much belongs to the
owners and others.
The financial performance reflects how the business has performed, whether it has made profits
or losses.
Changes in financial positions determine whether the resources have increased or reduced. The
users of accounting information have an interest in the existence of the firm. Therefore the
information contained in the financial statements will affect the decision making process.
i. Owners:
They have invested in the business and examples of such owners include sole traders, partners
(partnerships) and shareholders (company). They would like to have information on the financial
performance, financial position and changes in financial position.
This information will enable them to assess how the managers of the business are performing
whether the business is profitable or not and whether to make drawings or put in additional
capital.
ii. Customers
Customers rely on the business for goods and services. They would like to know how the
business is performing and its financial position. This information would enable them to assess
whether they can rely on the firm for future supplies.
iii. Suppliers
They supply goods or services to the firm. The supplies are either for cash or credit. The
suppliers would like to have information on the financial performance and position so as to
assess whether the business would be able to pay up for the goods and services provided as and
when the payments fall due.
iv. Managers
The managers are involved in the day-to-day activities of the business. They would like to have
information on the financial position, performance and changes in financial position so as to
determine whether the business is operating as per the plans. In case the plan is not achieved then
the managers come up with appropriate measures (controls) to ensure that the set plans are met.
v. The Lenders
They have provided loans and others sources of capital to the business. Such lenders include
banks and other financial institutions. They would like to have information on the financial
performance and position of the business to assess whether the business is profitable enough to
pay the interest on loans and whether it has enough resources to pay back the principal amount
when it is due.
a) Be represented faithfully,
b) Be accounted for and presented in accordance with their substance and economic reality and
not merely their legal form,
c) Be neutral i.e. free from bias,
d) Include some degree of caution especially where uncertainties surround some events and
transactions (prudence),
e) Be complete i.e. must be within the bounds of materiality and cost. An omission can cause
information to be false.
4. Comparability: users must be able to compare the financial statements of an enterprise
through time in order to identify trends in its financial position and performance. Users
must also be able to compare the financial statements of different accounting policies,
changes in the various policies and the effect of these changes in the accounts.
Compliance with accounting standards also helps achieve this comparability
5. Timely. If the accounting information is not availed to the deserving user at the time of
need, then it may as well be useless. For accounting information to be useful, it must be
presented to the party in need at the time of the need.
Assets:
An asset is a resource controlled by a business entity/firm as a result of past events for which economic
benefits are expected to flow to the firm. An example is if a business sells goods on credit then it has an
asset called a debtor. The past event is the sale on credit and the resource is a debtor. This debtor is
expected to pay so that economic benefits will flow towards the firm i.e. in form of cash once the
customers pays.
Noncurrent assets are acquired by the business to assist in earning revenues and not for resale. They are
normally expected to be in business for a period of more than one year.
Major examples include:
Land and buildings
Plant and machinery
Fixtures, furniture, fittings and equipment
Motor vehicles
Current assets are not expected to last for more than one year. They are in most cases directly related to
the trading activities of the firm. Examples include:
Stock of goods – for purpose of selling.
Trade debtors/accounts receivables – owe the business amounts as a resort of trading.
Other debtors – owe the firm amounts other than for trading.
Cash at bank.
Cash in hand.
Prepaid expenses
Liabilities:
These are obligations of a business as a result of past events settlement of which is expected to result to
an economic outflow of amounts from the firm. An example is when a business buys goods on credit,
then the firm has a liability called creditor. The past event is the credit purchase and the liability being the
creditor the firm will pay cash to the creditor and therefore there is an out flow of cash from the business.
Non-current liabilities are expected to last or be paid after one year. This includes long-term loans
from banks or other financial institutions. Current liabilities last for a period of less than one year and
therefore will be paid within one year. Major examples:
1. Trade creditors/or accounts payables – owed amounts as a result of business buying goods on
credit.
2. Other creditors - owed amounts for services supplied to the firm other than goods.
3. Bank overdraft - amounts advanced by the bank for a short-term period.
4. Prepaid incomes
Capital:
This is the residual amount on the owner’s interest in the firm after deducting liabilities from the assets.
The Accounting equation can be expressed in a simple report called the Balance Sheet. The basic format
is as follows:
Name of entity
Balance sheet as at XXX.
Non-Current Assets Sh Sh Sh
Land & Buildings xx
Plant & Machinery xx
Fixtures, furniture & fittings xx
Motors vehicles xx
xx
Current Assets
Stocks/inventories xx
Debtors/ trade receivables xx
Cash at bank xx
Cash in hand xx
Current Liabilities
Bank Overdraft xx
Creditors/trade payables xx (xx)
Net Current Assets/Liabilities xx
Net assets xx
Capital xx
Non-Current Liabilities
Loan (from bank or other sources) xx
xx
Please pay attention to the format. The Non-Current assets are listed in order of permanence as
shown i.e. from Land and Buildings to motor vehicles. The Current Assets are listed in order of
liquidity i.e. which asset is far from being converted into cash. Example, stock is not yet sold,
(i.e. not yet realised yet) then when it is sold we either get cash or a debtor (if sold on credit).
When the debtor pays then the debtor may pay by cheque (cash has to be banked) or cash.
The Current Liabilities are listed in order of payment i.e. which is due for payment first. Bank overdraft
is payable on demand by the bank, then followed by creditors. Note that in the vertical format, current
liabilities are deducted from current assets to give net current assets. This is added to Non-Current assets,
which give us net assets. Net assets should be the same as the total of Capital and Non-Current Liabilities.
Exercise one
Onyango has a business that has been trading for some time. You are given the following
information as at 31st December 2019
‘000’
Land and Buildings 11,000
Furniture & Fittings 5,500
Motor Vehicles 5,800
Stocks 8,500
Debtors 5,600
Bank 1,500
Cash 400
Creditors 2,500
Capital 30,800
Loan 5,000
Exercise two
Kamau sets up a new business. Before he actually sells anything, he buys motor vehicles of
3,000,000, premises of 7,000,000, stock of goods 2,000,000 which he still owes 800,000 in
respect of them. He borrows 4,000,000 from Evans. After the events described and before
trading starts, he has 300,000 cash and 600,000 in the bank.
Required: Calculate the amount of his capital and prepare the statement of financial position
(balance sheet)