Financial Accounting for Decision Makers

Jerry and Company
Statement of financial position as at 7 March
£
ASSETS
Cash at bank (17,000
+
5,000)
22,000
Motor van
5,000
Inventories (3,000
-
3,000)
–
Total assets
27,000
EQUITY AND LIABILITIES
Equity (10,000
+
(5,000
-
3,000))
12,000
Liabilities – borrowing
12,000
Liabilities – trade payable
3,000
Total equity and liabilities
27,000
What would have been the effect on the statement of financial position if the inventories 
had been sold on 7 March for £1,000 rather than £5,000?
The statement of financial position on 7 March would then have been:
Activity 2.8
Jerry and Company
Statement of financial position as at 7 March
£
ASSETS
Cash at bank (17,000
+
1,000)
18,000
Motor van
5,000
Inventories (3,000
-
3,000)
–
Total assets
23,000
EQUITY AND LIABILITIES
Equity (10,000
+
(1,000
-
3,000))
8,000
Liabilities – borrowing
12,000
Liabilities – trade payable
3,000
Total equity and liabilities
23,000
M02 Atrill's Financial Accounting For Decis 51257.indd 46
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CLASSIFYING ASSETS 
47
What we have just seen means that the accounting equation can be extended as follows:
Assets 
1
at the end of the period
2
=
Equity 
1
amount at the start of the period)
+
Profit 
1
or Loss
2
 for the period
2
+
Liabilities 
1
at the end of the period
2
(This is assuming that the owner makes no injections or withdrawals of equity during the 
period.)
Any funds introduced or withdrawn by the owners also affect equity. If the owners with-
drew £1,500 for their own use, the equity of the owners would be reduced by £1,500. If these 
drawings were in cash, the cash balance would decrease by £1,500 in the statement of 
financial position.
Like all items in the statement of financial position, the amount of equity is cumulative. This 
means that any profit not taken out as drawings by the owner(s) remains in the business. 
These retained (or ‘ploughed-back’) earnings have the effect of expanding the business.
CLASSIFYING ASSETS
In the statement of financial position, assets and claims are usually grouped into categories. 
This is designed to help users, as a haphazard listing of these items could be confusing. 
Assets are usually categorised as being either current or non-current.
Current assets
Current assets
are basically assets that are held for the short term. To be more precise, they 
are assets that meet any of the following conditions:
■ 
they are held for sale or consumption during the business’s normal operating cycle;
■ 
they are expected to be sold within a year after the date of the relevant statement of finan-
cial position;
■ 
they are held principally for trading; and
■ 
they are cash, or near cash such as easily marketable, short-term investments.
The operating cycle of a business, mentioned above, is the time between buying and/or 
creating a product or service and receiving the cash on its sale. For most businesses, this will 
be less than a year. (It is worth mentioning that sales made by most businesses are made on 
credit. The customer pays some time after the goods are received or the service is rendered.)
The most common current assets are inventories, trade receivables (amounts owed by 
customers for goods or services supplied to them on credit) and cash. For businesses that 
sell goods, rather than render a service, the current assets of inventories, trade receivables 
and cash are interrelated. They circulate within a business as shown in Figure 2.3. We can 
see that cash can be used to buy inventories, which are then sold on credit. When the credit 
customers (trade receivables) pay, the business receives an injection of cash and so on.
As we can see, the inventories (£3,000) will disappear from the statement of financial posi-
tion, but the cash at bank will rise by only £1,000. This will mean a net reduction in assets 
of £2,000. This reduction represents a loss arising from trading and will be reflected in a 
reduction in the equity of the owners.
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