What is a Balance Sheet or Statement of Financial Position?

What is a balance sheet or a statement of financial position? Among the five components of a complete set of financial statements (i.e., balance sheet, statement of comprehensive income (income statement), statement of cash flow, statement of changes in equity and notes to financial statements) the balance sheet or the statement of financial position is the first financial statement presented. The reason why it is presented first is because it gives a “snapshot of a company’s financial condition. It shows the financial information that a user can look on to have a bigger picture of an entity’s basic financial information, such as cash and equity. Cash flows are further presented in the statement of cash flow, while the details and movements of equity are further shown in the statement of changes in equity. Moreover, the changes in equity which includes the net income or profit for the period is presented in detailed in the statement of income.

The balance sheet is also reported as at the company’s reporting period (e.g., as at December 31 2010) unlike the other financial statements that are reported for the accounting period (e.g., for the year ended December 31, 2010). The balance sheet reports a company’s assets, liabilities and equity, which shows the basic accounting equation (assets = liabilities + equity), where the assets must always be balanced with the total of the liabilities and equity.

Presentation of the balance sheet
According to International Accounting Standard (IAS) 1, an entity must normally present a classified statement of financial position, separating current and noncurrent assets and liabilities. Current assets are cash; cash equivalent; assets held for collection, sale, or consumption within the entity’s normal operating cycle; or assets held for trading within the next 12 months. All other assets are noncurrent (IAS 1.66). Current liabilities are those expected to be settled within the entity’s normal operating cycle or due within 12 months, or those held for trading, or those for which the entity does not have an unconditional right to defer payment beyond 12 months. Other liabilities are noncurrent (IAS 1.69).

Items on the statement of financial position
When applicable, the minimum items on the face of the statement of financial position are the following (IAS 1.54):

(a) property, plant and equipment
(b) investment property
(c) intangible assets
(d) financial assets (excluding amounts shown under (e), (h), and (i))
(e) investments accounted for using the equity method
(f) biological assets
(g) inventories
(h) trade and other receivables
(i) cash and cash equivalents
(j) assets held for sale
(k) trade and other payables
(l) provisions
(m) financial liabilities (excluding amounts shown under (k) and (l))
(n) liabilities and assets for current tax, as defined in IAS 12
(o) deferred tax liabilities and deferred tax assets, as defined in IAS 12
(p) liabilities included in disposal groups
(q) non-controlling interests, presented within equity and
(r) issued capital and reserves attributable to owners of the parent

Additional line items may be needed to fairly present the entity’s financial position (IAS 1.54). IAS 1 does not prescribe the format of the balance sheet. Assets can be presented current then noncurrent, or vice versa, and liabilities and equity can be presented current then noncurrent then equity, or vice versa.

The purpose of balance sheet
By the way, the term balance sheet and statement of financial position is used interchangeably in this article. However, in 2007, IAS 1 amended the term “balance sheet” to “statement of financial position”. That is why you will notice that the latter terminology is commonly used by most reporting entities today. Going back to the purpose of the statement of financial position, many users such as business owners, managers, investors, creditors, government regulatory agencies and other users use it to analyze an entity’s financial stability. The statement also shows the company’s liquidity, efficiency and solvency. A creditor can check the company’s working capital (current assets minus current liabilities) to determine whether the company will be able to meet its current obligations. Management can also determine if the company is efficient in collecting its receivables (accounts receivables turnover) and in selling its inventories (inventory turnover). Further, business owners and investors can also check the proportion of equity and debt the company is using to finance its assets or its financial leverage through its debt-to-equity ratio. Financial leverage is the degree to which an investor or business is utilizing borrowed money. Companies that are highly leveraged may be at risk of bankruptcy if they are unable to settle their debt; they may also be unable to find new lenders in the future.

To see sample audited statements of financial position of public listed companies in the Philippines, please visit this post.