CAT / FIA FFA Syllabus A. The Context And Purpose Of Financial Reporting - Definitions of Assets Liabilities ... - Notes ^{2 / 2}

Assets

An asset is something valuable which a business owns or can use. 

'An asset is 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.‘

Some assets are held and used in operations for a long time.  These are known as non-current assets.

Other assets are held for only a short time.  They are likely to be realized within the normal operating cycle or 12 months after the end of the reporting period. These are classified as current assets.

Liabilities

A liability is something which is owed to somebody else. 

'Liabilities' is the accounting term for the debts of a business. 

'A liability is a present obligation of the entity to transfer economic resource as a result of past events.
An obligation is a duty of responsibility that the entity has no practical ability to avoid.‘

Some liabilities are due to be settled within the normal operating cycle or 12 months after the end of the reporting period. These are classified as current liabilities.  

Other liabilities may take some years to repay – non-current liabilities.

Capital / Equity

Capital is the amount invested in a business by the owner.  This is the amount the business owes to the owner.  In the case of a sole trader,

CAPITAL = ASSETS – LIABILITIES

CAPITAL = NET ASSETS

In the case of a limited liability company, capital usually takes the form of shares. 

Share capital is known as equity. 

The Framework defines equity as “the residual interest in the assets of the entity after deducting all its liabilities.”

Revenue

Revenue is the income generated by the operations of a business for a period.

'lncome is increases in assets or decreases in liabilities that result in increases in equity, other than those relating to contributions from holders of equity claims.‘

Expenses

Expenses are the costs of running the business for the same period.

'Expenses are decreases in assets or increases in liabilities that result in decreases in equity, other than those relating to distributions to holders of equity claims.‘

Notes

1. The top part of the statement of profit or loss, i.e. Sales – Cost of Sales = Gross Profit, is called the Trading Account. It records the trading activities of the business.

2. Sundry income includes bank interest, rent receivable, income from investments.

3. Carriage inwards is the cost of transport of goods into the firm and is therefore added to the purchases figure.

4. Carriage outwards is the cost of transport of goods out of the firm to its customers, it is not part of the firm's expenses in buying the goods and is always entered as an expense.

Sole trader’s profit

= Closing capital + Drawings - Capital introduced - Opening Capital

Therefore, the capital of a sole trader would change as a result of something like wages being paid in cash, it will not be affected transactions that affect assets (purchase of raw materials or non current assets) and liabilities (settling of payables), as these are dealt with separately in the accounting equation.