Learning Unit1 | US:12935, NQF Level 7 Worth 8 Credits RECOGNISE, MEASURE, CLASSIFY AND RECORD FINANCIAL AND NON-FINANCIAL DATA |
Unit Standard Purpose | A person credited with this unit standard is generally found within the financial accounting field. On successful completion of the unit standard, a person will be able to recognise, measure, classify and record accounting and non-financial data. |
Learning Assumed to be in Place | Unit standard, Manage accounting systems, NQF level 5. |
Session 1 SO 1 | Recognise financial and non-financial data. |
Learning Outcomes (Assessment Criteria) | · Assets and liabilities in general purpose financial statements are recognised and selected accurately. · Elements of financial position are recognised. · Elements of performance in relevant statements are recognised. · Non-financial information is recognised in terms of importance and relevance. |
Assets and liabilities in general purpose financial statements are recognised and selected accurately.
What are liabilities in a financial statement?
Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses. In general, a liability is an obligation between one party and another not yet completed or paid for.
What Is a Liability?
A liability is something a person or company owes, usually a sum of money. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services. Recorded on the right side of the balance sheet, liabilities include loans, accounts payable, mortgages, deferred revenues, bonds, warranties, and accrued expenses.
In general, a liability is an obligation between one party and another not yet completed or paid for. In the world of accounting, a financial liability is also an obligation but is more defined by previous business transactions, events, sales, exchange of assets or services, or anything that would provide economic benefit at a later date. Liabilities are usually considered short term (expected to be concluded in 12 months or less) or long term (12 months or greater).
Liabilities are also known as current or non-current depending on the context. They can include a future service owed to others; short- or long-term borrowing from banks, individuals, or other entities; or a previous transaction that has created an unsettled obligation. The most common liabilities are usually the largest like accounts payable and bonds payable. Most companies will have these two-line items on their balance sheet, as they are part of ongoing current and long-term operations.
What’s a Liability?
Liabilities Explained
Liabilities are a vital aspect of a company because they are used to finance operations and pay for large expansions. They can also make transactions between businesses more efficient. For example, in most cases, if a wine supplier sells a case of wine to a restaurant, it does not demand payment when it delivers the goods. Rather, it invoices the restaurant for the purchase to streamline the dropoff and make paying easier for the restaurant.
The outstanding money that the restaurant owes to its wine supplier is considered a liability. In contrast, the wine supplier considers the money it is owed to be an asset.
Other Definitions of Liability
Generally, liability refers to the state of being responsible for something, and this term can refer to any money or service owed to another party. Tax liability, for example, can refer to the property taxes that a homeowner owes to the municipal government or the income tax he owes to the federal government. When a retailer collects sales tax from a customer, they have a sales tax liability on their books until they remit those funds to the county/city/state.
Liability may also refer to the legal liability of a business or individual. For example, many businesses take out liability insurance in case a customer or employee sues them for negligence.
Current Versus Long-Term Liabilities
Businesses sort their liabilities into two categories: current and long-term. Current liabilities are debts payable within one year, while long-term liabilities are debts payable over a longer period. For example, if a business takes out a mortgage payable over a 15-year period, that is a long-term liability. However, the mortgage payments that are due during the current year are considered the current portion of long-term debt and are recorded in the short-term liabilities section of the balance sheet.
Ideally, analysts want to see that a company can pay current liabilities, which are due within a year, with cash. Some examples of short-term liabilities include payroll expenses and accounts payable, which includes money owed to vendors, monthly utilities, and similar expenses. In contrast, analysts want to see that long-term liabilities can be paid with assets derived from future earnings or financing transactions. Bonds and loans are not the only long-term liabilities companies incur. Items like rent, deferred taxes, payroll, and pension obligations can also be listed under long-term liabilities.
What Is the Difference Between an Expense and a Liability?
An expense is the cost of operations that a company incurs to generate revenue. Unlike assets and liabilities, expenses are related to revenue, and both are listed on a company’s income statement. In short, expenses are used to calculate net income. The equation to calculate net income is revenues minus expenses.
For example, if a company has more expenses than revenues for the past three years, it may signal weak financial stability because it has been losing money for those years.
Expenses and liabilities should not be confused with each other. One is listed on a company’s balance sheet, and the other is listed on the company’s income statement. Expenses are the costs of a company’s operation, while liabilities are the obligations and debts a company owes. Expenses can be paid immediately with cash, or the payment could be delayed which would create a liability.
Like most assets, liabilities are carried at cost, not market value, and under GAAP rules can be listed in order of preference as long as they are categorized. The AT&T example has a relatively high debt level under current liabilities. With smaller companies, other line items like accounts payable (AP) and various future liabilities like payroll, taxes, and ongoing expenses for an active company carry a higher proportion.
AP typically carries the largest balances, as they encompass the day-to-day operations. AP can include services, raw materials, office supplies, or any other categories of products and services where no promissory note is issued. Since most companies do not pay for goods and services as they are acquired, AP is equivalent to a stack of bills waiting to be paid.
Examples of Common Current Liabilities
Less Common Current Liabilities
Since most companies do not report line items for individual entities or products, this entry points out the implications in aggregate. As there are estimates used in some of the calculations, this can carry significant weight.
A good example is a large technology company that has released what it considered to be a world-changing product line, only to see it flop when it hit the market. All the R&D, marketing and product release costs need to be accounted for under this section.
Non-Current Liabilities
Considering the name, it’s quite obvious that any liability that is not current falls under non-current liabilities expected to be paid in 12 months or more. Referring again to the AT&T example, there are more items than your garden variety company that may list one or two items. Long-term debt, also known as bonds payable, is usually the largest liability and at the top of the list.
Companies of all sizes finance part of their ongoing long-term operations by issuing bonds that are essentially loans from each party that purchases the bonds. This line item is in constant flux as bonds are issued, mature, or called back by the issuer.
Example of Common Non-Current Liabilities
Less Common Non-Current Liabilities
Three Major Financial Statements
The information found on the financial statements of an organization is the foundation of corporate accounting. This data is reviewed by management, investors, and lenders for the purpose of assessing the company’s financial position.
Data found in the balance sheet, the income statement, and the cash flow statement is used to calculate important financial ratios that provide insight on the company’s financial performance and potential issues that may need to be addressed. The balance sheet, income statement, and cash flow statement each offer unique details with information that is all interconnected. Together the three statements give a comprehensive portrayal of the company’s operating activities.
The Balance Sheet
Also referred to as the statement of financial position, a company’s balance sheet provides information on what the company is worth from a book value perspective. The balance sheet is broken into three categories and provides summations of the company’s assets, liabilities, and shareholders’ equity on a specific date.
Generally, a comprehensive analysis of the balance sheet can offer several quick views. In order for the balance sheet to ‘balance,’ assets must equal liabilities plus equity. Analysts view the assets minus liabilities as the book value or equity of the firm. In some instances, analysts may also look at the total capital of the firm which analyzes liabilities and equity together. In the asset portion of the balance sheet, analysts will typically be looking at long term assets and how efficiently a company manages its receivables in the short-term.
There are a variety of ratios analysts use to gauge the efficiency of a company’s balance sheet. Some of the most common include asset turnover, the quick ratio, receivables turnover, days to sales, debt to assets, and debt to equity.
The Income Statement
A company’s income statement provides details on the revenue a company earns and the expenses involved in its operating activities. Overall, it provides more granular detail on the holistic operating activities of a company. Broadly, the income statement shows the direct, indirect, and capital expenses a company incurs.
Starting with direct, the top line reports the level of revenue a company earned over a specific time frame. It then shows the expenses directly related to earning that revenue. Direct expenses are generally grouped into cost of goods sold or cost of sales which represents direct wholesale costs. Costs of sales are subtracted from revenue to arrive at gross profit. Gross profit is then often analyzed in comparison to total sales to identify a company’s gross profit margin.
Indirect expenses are also an important part of the income statement. Indirect expenses form a second category and show all costs indirectly associated with the revenue-generating activities of a firm. These costs can include salaries, general and administrative expenses, research and development, and depreciation and amortization. Together these indirect expenses are subtracted from gross profit to identify operating income.
The final category on the income statement factors in capital expenses. The last expenses to be considered here include interest, tax, and extraordinary items. The subtraction of these items results in the bottom-line net income or total amount of earnings a company has achieved.
Offering a great deal of transparency on the company’s operating activities, the income statement is also a key driver of the company’s other two financial statements. Net income at the end of a period becomes part of the company’s short-term assets. Net income is also carried over to the cash flow statement where it serves as the top line item for operating activities. Sales booked during the period are also added to the company’s short-term assets as accounts receivable.
On the income statement, analysts will typically be looking at a company’s operating efficiency. Therefore, key ratios used for analyzing the income statement include gross margin, operating margin, and net margin as well as tax ratio efficiency and interest coverage.
The Cash Flow Statement
The cash flow statement provides a view of a company’s overall liquidity by showing cash transaction activities. It reports all cash inflows and outflows over the course of an accounting period with a summation of the total cash available.
Standard cash flow statements will be broken into three parts: operating, investing, and financing. This financial statement highlights the net increase and decrease in total cash in each of these three areas.
The operating portion is closely tied with the income statement, showing cash generated from net earnings on the top line. The operating cash activities also include depreciation and amortization, and any operating write-offs such as uncollected accounts receivable.
The other two portions of the cash flow statement, investing and financing, are closely tied with the capital planning for the firm which is interconnected with the liabilities and equity on the balance sheet. Investing cash activities primarily focus on assets and show asset purchases and gains from invested assets. The financing cash activities focus on capital structure financing, showing proceeds from debt and stock issuance as well as cash payments for obligations such as interest and dividends.
A Comprehensive View
All three accounting statements are important for understanding and analyzing a company’s performance from multiple angles. The income statement provides deep insight into the core operating activities that generate earnings for the firm. The balance sheet and cash flow statement, however, focus more on the capital management of the firm in terms of both assets and structure.
Overall, top performing companies will achieve high marks in operating efficiency, asset management, and capital structuring. Management is responsible for overseeing these three levers in a way that serves the best interest of the shareholders, and the interconnected reporting of these levers is what makes financial statement reporting so important.
What is financial and non-financial data?
Information such as total sales of a company, expense figures such as advertising costs or dollar values of assets such as land and building are some examples of financial information. Non-financial information, however, is not or cannot be readily expressed in dollar values.
What are non-financial indicators?
A key performance indicator (KPI) is a measure used to reflect organisational success or progress in relation to a specified goal. … Typical non-financial KPIs include measures that relate to customer relationships, employees, operations, quality, cycle-time, and the organisation’s supply chain or its pipeline
Nonfinancial Vs. Financial Information
When you make plans or decisions for your company, you need financial information, but nonfinancial information is often important as well. Examples of nonfinancial information include your company’s environmental impact, the effect on housing and roads and cases of discrimination or sexual harassment.
Financial vs. Nonfinancial
Potentially everything your business does has a financial impact. Lawyers’ fees for fighting a sexual harassment lawsuit will affect your bottom line, for example. If you have to settle or pay damages, the effect will be greater.
Even so, looking at examples of financial data and nonfinancial data show that there’s a difference. Financial data examples include advertising costs, sales revenue, employee compensation and the value of assets. Examples of nonfinancial information include environmental impact, your relationship with your vendors, diversity in the workplace and social responsibility. They may have financial impacts, but it’s impossible to quantify them purely by assigning them a dollar figure.
Nonfinancial Data and Investment
The focus of any business decisions is usually profit and loss. How much will it cost us? What are the potential rewards? What’s the risk of loss? However, there are also times when nonfinancial information is required for an investment decision.
Nonfinancial data is also important for internal decision making. Cutting employee benefits and bonuses might improve your bottom line in the short term, but if it damages employee morale and loyalty, it’ll hurt in the long run.
Examples of Nonfinancial Information Benefits
Measuring whether sales revenue rises or falls between this quarter and the last is simple. Measuring customer loyalty, employee commitment or environmental impact takes more work, but it offers rewards:
Obstacles to Reporting
Nonfinancial reporting isn’t new. Companies who have made it a priority have experienced examples of nonfinancial reporting roadblocks – obstacles for which you need to be ready:
Nonfinancial Reporting
In the nonfinancial reporting is valuable, but it isn’t required. If you do business in the European Union and you have more than 500 people on staff there, reporting nonfinancial information became mandatory in 2018.
All members of the EU have adopted the Non-Financial Reporting Directive, but they’ve adopted it to different degrees. Your responsibilities vary nation to nation. The directive requires reporting in several categories:
The specific requirements and the reporting details in each of these categories are shaped by individual national policies. France, for example, has adopted reporting requirements that are much tougher than the baseline directive.
What Is Social Responsibility Accounting?
Social responsibility accounting – sometimes referred to as sustainability accounting or corporate social responsibility accounting – is the concept of integrating nonfinancial measures into financial reporting. Although social responsibility accounting and reporting aren’t mandatory for businesses, companies do at times report on social issues
Definition of Social Responsibility Accounting
According to the American Institute of CPAs, sustainability accounting involves reporting a “triple bottom-line” of a company’s economic vitality, social responsibility and environmental responsibility. In the past, business philosophy in the has tasked company managers with driving profits for shareholders. More and more, individuals and institutions are concerned with how business operations affect employees, customers, the community and the natural environment. Social responsibility accounting seeks to quantify and report on this information.
Information Reported Under Social Responsibility Accounting
Companies that employ social responsibility accounting may report on some or all of the following issues:
Reporting Framework for Social Responsibility Accounting
It’s important for accounting information to be comparable, so companies that use social responsibility accounting need a consistent framework to work under. Companies can currently use the Global Reporting Initiative Framework, which the AICPA calls the de facto standard for sustainability reporting. Leading professionals in the fields of business, accounting and regulation have formed a Climate Disclosures Standards Board to develop a framework for environmental reporting.
Use of Social Responsibility Accounting
Companies that have stock listed on a stock exchange are required to report their financial information, but are not required to report on their social and sustainability information. Because of this, not many businesses report the information thoroughly. According to a 2013 study performed by the Investor Responsibility Research Institute, only 1.4 percent of companies listed in the S&P 500 – seven, to be exact – issue a full-fledged statement on sustainability reporting. However, all but one of the S&P 500 makes some sort of disclosure about sustainability, and nearly half link executive compensation to some sort of sustainability criteria.
Is Nonfinancial Information as Important as Financial Information in the Decision-Making Process?
Before making an important decision, most people consider qualitative and quantitative factors, as well as how both categories may interrelate down the road. Businesses also pay attention to financial and nonfinancial information before taking a competitive stand. In a modern economy in which commercial activities are hardly a linear set of experiences, corporate leadership must factor in the economics of each transaction but also the specific context for each business decision.
Nonfinancial Information
In the business environment, investors and regulators rely on various tools to gauge nonfinancial information. The arsenal available to these groups consists of two categories: internal and external. Internal information relates to such data as human resources management objectives, governance policies and management’s strategic vision. Corporate observers may use this organic information to identify effective internal controls, as well as to uncover improper and otherwise inappropriate business methods — such as fraudulent or illegal activities. External information comes primarily from the marketplace and concerns everything from competitors’ moves and lending conditions to business legislation.
Financial Information
A company that does not publish accurate performance data may feel itself beset with forces asking for more transparency. Various groups, from shareholders to regulators and the public, may require that top management put into place sound procedures for financial-statement presentation and reporting. This increased interest in accounting statements comes from the fact that financial information is often key in decision making. A firm’s accounting data summaries are rich with information about solvency, profitability and liquidity. Examples include balance sheets, statements of cash flows and statements of profit and loss.
Decision-Making Process
Nonfinancial information is as important as financial information in the decision-making process. Both pieces of data contain valuable insights that can yield interesting results if used correctly. To make a decision, businesses often rely on PDCA analysis or adopt specific steps. These include clearly defining the problem, evaluating potential alternatives, choosing the best option based on existing alternatives, monitoring implementation strategies and checking progress periodically. PDCA (plan, do, check, act) helps a company take a thorough look at its operating processes and come up with better ways to accomplish specific tasks and eliminate money-losing activities. Economists use the terms “PDCA,” “Deming wheel” and “Shewhart cycle” interchangeably.
Personnel Involvement
Making proper decisions is the responsibility of corporate management, but department heads and segment chiefs also weigh in on decision making. This collaboration — and the increased task delegation that ensues — help senior leadership focus on major initiatives that will improve sales, trump rivals and enable the firm to control its patterns of growth. Rank-and-file personnel also contribute their insights in corporate decision making, working in tandem with segment chiefs to improve productivity
The Disadvantages of Balanced Scorecards
A balanced scorecard evaluates business performance against a range of factors. Traditionally, businesses measure performance by financial results. However, this gives a historical picture with a single focus. Balanced scorecards also focus on customers, business processes and organizational capacity, enabling you to improve future performance based on a broader range of results. However, balanced scorecard systems are not perfect and have some disadvantages.
Time and Financial Cost Investment
Balanced scorecard systems require a significant investment. This is a long-term rather than a short-term solution. A company must manage its system actively and constantly, which comes with time and financial costs. All employees need to understand how the system works, which may increase training expenses. If you don’t have internal expertise, you may have to hire external consultants to help you implement the system and learn how to use it. You also may need to factor in software purchasing and maintenance costs.
Stakeholder Acceptance and Usage
All employees should buy into a balanced scorecard system for it to work effectively. This may be more difficult than you think. If employees don’t understand how the system works or cannot see its benefits, they may not invest in it. Those resistant to change may have problems accepting a new system. Even if you gain acceptance, training must enable employees to use the system correctly. Over time, some employees may become frustrated if they don’t see tangible benefits or if they perceive scorecards as an added pressure on their workloads rather than a useful tool.
Strategic Direction and Metric Planning
An effective balanced scorecard system aligns with your strategic objectives, breaking them into measurable metrics. If you don’t plan and communicate these elements with and to your stakeholders, the system may not produce the desired results. It may become bloated and hard to manage if you add too many objectives or metrics to the mix. If controls and measurements are inconsistent, they may not produce the same benefits across your business. Putting too much focus on metrics can divert you from your overall strategic direction.
Data Collection and Analysis
You may need to train users so that they understand when and how to measure and analyze data. Balanced scorecards may give you useful information on areas that require improvement, but you have to be able to spot these indicators and then implement an appropriate strategy yourself. Scorecard results can only be as good as the underlying data that supports them. If you don’t set appropriate data measures and don’t input the right information consistently, you run the risk of getting inaccurate results. This could prompt you to work on areas that don’t need improvement and to ignore areas that do.
Lack of External Focus
Balanced scorecards may give you a broader internal focus, but they do not give a full external picture. As a default, they consider your customers but they do not factor in other key performance indicators, such as your competitors or changes to your business environment, for example. This may lead to an over-emphasis on internal performance and a lack of awareness of external factors that also could influence your company’s operations.
Differences Between Audited & Unaudited Financial Statements
Your company’s cash flow statement, income statement and balance sheet give readers key financial facts. Is your business mired in debt? Are your customers paying on time? Audited financial statements have been reviewed by an outside accountant who confirms the information is accurate. That gives lenders and investors confidence you’re not fudging the facts to make your company look more profitable than it is. With unaudited accounts, they don’t have that guarantee.
Audits
The basic financial statements each provide different information about your company’s finances.
The balance sheet compares your company’s total assets with the debts the business owes. Assets minus debts are equal to the owner’s equity.
The income statement shows the income and expenses for a given period, and the net profit or loss.
The cash flow statement measures the actual cash earned and spent. Unlike the income statement, it doesn’t deal with transactions on credit.
The retained earnings statement covers changes in owner’s equity for the period. It’s the least used of the basic statements.
Having unaudited statements isn’t automatically a bad thing. Unaudited financial statements show the same financial data as audited ones. But it’s quicker and cheaper to draw them up than to go through the audit process. If, say, you want a cash flow statement for the month because you want to know how much money you have on hand, you can pay for a statement. This is sometimes called compilation accounting because the accountant compiles the statements from the raw data you provide.
If you’re presenting a prospectus to potential investors, however, they’ll want the security of audited financial statements. If you’re a publicly traded company, federal regulators require that you file audited statements every year. You can still compile unaudited statements for your own use.
Audited Financial Statements
One reason audited financial statements cost more is that you have to use a certified public accountant to do the job. Compilation accounting takes your word for the accuracy of the information, but the auditor has to dig deeper. An audited balance sheet means, for example, the auditor has double-checked the information. If you report R30,000 in inventory as an asset, the auditor may inspect the inventory, or all items over a certain value, to confirm its existence.
The auditor also looks at your internal controls. Controls include, for example, internal watchdogs who monitor how money is spent. If the people authorized to spend money have nobody checking behind them, the auditor will double-check for possible fraud.
The Auditor Gives Opinions
In compilation accounting, you don’t have to care what your accountant’s opinion of the statements is. When a CPA audits your statement, their opinion matters big-time:
An unmodified or unqualified opinion is the result you want. The auditor says that, in their opinion, everything in the statements is accurate and your bookkeeping conforms to standard accounting practice.
A qualified opinion lists various problems or absent information in your statement. The auditor’s saying that everything looks good except for these weak points.
An adverse opinion is seriously bad news: it says your statements don’t present your finances accurately. Investors, lenders and regulators can’t rely on the information in the statements.
A disclaimer of opinion is bad news too. The auditor’s refusing to give an opinion, for example, because you didn’t provide the necessary information or didn’t allow time enough for a thorough audit.
If the opinion isn’t favorable, the auditor will provide information on what the problems are. Common problems include a lack of information or a failure to follow standard accounting rules. If you fix the problems and resubmit the statements, the auditor should be willing to accept the changes and issue an unqualified opinion.
Ethical Issues Facing Financial Managers
Financial managers prepare reports, oversee accounting functions, plan investment strategies and direct cash management functions. They also are involved in branch management functions at banks and other financial institutions. They are required to uphold the highest ethical standards because internal and external stakeholders depend on transparent, timely and complete financial documents to make decisions.
Accuracy
A company’s financial manager ensures that all financial publications accurately and fairly reflect the financial condition of the company. Accounting errors and financial fraud, such as what was seen in the cases of Enron and WorldCom, damage the interests of shareholders, employees and affect confidence in the financial system. Some organizations document ethics guidelines specifically for financial managers. For example, the ethics code of the United States Postal Service requires senior financial managers to maintain accurate records and books, maintain internal controls and prepare financial documents in accordance with generally accepted accounting principles.
Transparency
Financial documents reflect a company’s performance relative to its peers, and its internal strengths and weaknesses. Regulatory agencies require publicly traded companies to submit periodic financial statements and make full disclosures of material information. A change in the senior executive ranks, buyout offers, loss or win of a major contract and new product launches are examples of material information. Transparency also means explaining financial information clearly, especially for those who aren’t familiar with the company’s operations. Financial managers should not hide, obscure or otherwise render relevant financial information impossible for ordinary shareholders to understand.
Timeliness
Timely financial information is just as important as accurate and transparent information. Management, investors and other stakeholders require timely information to make the right decisions. Many cases exist of a publicly traded company’s stock reacting sharply and negatively to negative earnings surprises or unpleasant product-related news. For example, a company should promptly disclose manufacturing problems that could temporarily affect sales. Similarly, the company should not hold back news of a major contract loss in the hope that it can replace the lost revenue with new contracts.
Integrity
Financial managers should strive for unimpeachable integrity. Customers, shareholders and employees should be able to trust a financial manager’s words. Managers should not allow prejudice, bias and conflicts of interest to influence their actions. Managers should disclose real or apparent conflicts of interest, such as an investment position in a stock or an ownership interest in one of the bidding companies for a procurement contract. The structure of certain stock-based incentive compensation schemes could also result in ethical issues. For example, managers might be tempted to manipulate stock prices by selectively disclosing or not disclosing relevant financial information.
Session 2 SO 2 |
Classify financial and non- financial data. |
Learning Outcomes (Assessment Criteria) | · Assets and liabilities in general purpose financial statements are classified as per relevant sections of the legislation. · Elements of financial position are classified as per relevant sections of the legislation. · Elements of performance in relevant statements are classified as per relevant sections of the legislation. · Non-financial data is classified in order of importance and relevance. |
Classify financial and non- financial data.
Financial and non-financial items
Assets include financial assets, such as cash, stocks, bonds and non-financial assets. Examples of non-financial assets include land, buildings, vehicles and equipment. Non-financial assets also include R&D, technologies, patents and other intellectual properties.
What is a Non-Financial Asset?
A non-financial asset refers to an asset that is not traded on the financial markets, and its value is derived from its physical characteristics rather than from contractual claims. Examples of non-financial assets include tangible assets, such as land, buildings, motor vehicles, and equipment, as well as intangible assets, such as patents, goodwill, and intellectual property.
Non-Financial Asset Examples
A company’s balance sheet includes several types of assets and liabilities. Assets include financial assets, such as cash, stocks, bonds and non-financial assets. Examples of non-financial assets include land, buildings, vehicles and equipment. Non-financial assets also include R&D, technologies, patents and other intellectual properties.
Why Non-Financial Assets Are Important
While financial assets pay the bills, non-financial assets are important in evaluating the long-term viability of a company. Non-financial assets are an important part of the company’s ability to incur debt by providing collateral with sustainable market value.
What Is a Nonfinancial Asset?
A nonfinancial asset is an asset that derives its value from its physical traits. Examples include real estate and vehicles. It also includes all intellectual property, such as patents and trademarks. The classification of possessions as nonfinancial assets is important to businesses as these items appear on a company’s balance sheet and determine a multitude of factors, such as a company’s market value and debt profile.
Understanding a Nonfinancial Asset
On a company’s balance sheet, nonfinancial assets stand in contrast to financial assets. Financial assets are based on a contractual claim rather than a physical net worth. Financial assets include stocks, bonds, and bank deposits and are generally easier to sell than nonfinancial assets.
The value of a financial asset can be based on the value of an underlying nonfinancial asset. For example, the value of a futures contract is based on the value of the commodities controlled by that contract. Commodities are tangible objects with inherent value, such as coffee or soybeans, while futures contracts, which do not have an inherent physical value, are an example of a financial asset.
Nonfinancial Assets vs. Financial Assets
Nonfinancial and financial assets differ based on how the assets are bought and sold. Many financial assets, such as stocks and bonds, will trade on exchanges and can be bought and sold on any business day that the exchange is open. It is easy to get the current market price to buy or sell these assets. As long as the market is liquid, there will be a buyer for every seller and vice versa.
On the other hand, a nonfinancial asset, such as a piece of equipment or a vehicle, can be challenging to sell because there is not an active market of buyers and sellers. The pricing of the nonfinancial item may be foggy as there is no market standard. Instead, many nonfinancial assets are sold when the seller finds a potential buyer and negotiates a sale price. The time it takes to find a buyer, make the sale, and distribute the physical asset, make nonfinancial assets illiquid.
Nonfinancial Assets as Collateral
Both financial and nonfinancial assets may be used as collateral to back secured debt, standing in contrast to unsecured debt, which is only backed by the borrower’s ability to pay. One factor that makes a form of collateral more attractive to the lender is the ability to quickly sell the asset if the borrower fails to make principal or interest payments. A financial asset that trades on an exchange, like a stock or bond, is easier to sell than a nonfinancial asset, so a financial asset is more attractive to a lender as collateral.
Assume, for example, that XYZ manufacturing needs a R100,000 line of credit to operate the business, and they put up R60,000 in investment securities and a R40,000 piece of equipment as collateral for the loan. If XYZ does not make principal and interest payments on the loan and defaults, the lender can sell the R60,000 in financial assets quickly to cover the loss. Finding a buyer for the equipment, however, may take longer, so the nonfinancial asset is less attractive as collateral.
Non-financial assets are important for companies, and they can be used as collateral when securing credit from financial institutions. They are included on the balance sheet, and financial analysts consider non-financial assets when evaluating the long-term viability of the company.
Understanding Non-Financial Assets
Unlike financial assets, there is no active market for buyers and sellers of non-financial assets. Also, there are no market standards for determining the pricing of non-financial assets, such as equipment or motor vehicles, and the value of an asset is determined based on its physical characteristics.
The seller of the non-financial asset only initiates a sale when they find a potential buyer and negotiates an agreeable purchase price for the asset. The sale process is considered complete when the buyer pays the full purchase price to the seller, and the seller transfers the asset to the new owner.
The sale of non-financial assets is more complicated than the sale of financial assets, which can be traded through an established active market. Financial assets, such as bonds and stocks, can be bought and sold at any time when the financial markets are open. The value of a financial asset is determined by the amount of risk associated with the specific asset, and its demand and supply in the market where they trade.
Other financial assets derive their value from another underlying asset. For example, futures contracts are based on the value of commodities, which are tangible assets with inherent value.
Types of Non-Financial Assets
Non-financial assets are classified into two types – produced assets and non-produced assets – based on how they came into existence.
Produced assets come into existence through the production or manufacturing process. The assets come with a residual value, which is realized when they are no longer needed and are available for sale.
Produced assets are not necessarily fixed assets in that fixed assets take on a useful life of more than one year, and they are capitalized in the balance sheet. On the other hand, other produced assets can be written off in the year of purchase or manufacturing.
Non-produced assets are the assets that come into existence through means other than the process of production but may be used in the production of goods and services. Examples of non-financial non-produced assets include natural resources (minerals, water resources, virgin forests, etc.) leases and licenses.
Non-produced assets may be classified into tangible assets and intangible assets. Tangible non-produced assets are natural assets that are capable of bringing economic benefits to their owners, and that are subject to effective ownership. Natural resources whose ownership rights cannot be established are excluded from non-produced assets.
Intangible non-produced assets include assets such as patents, purchased goodwill, and transferrable contracts.
Using Non-Financial Assets as Security for a Loan
When taking out a loan from financial institutions, borrowers may be required to provide non-financial assets, such as collateral, for secured debt. Borrowers are required to submit ownership documents for the assets before the credit can be approved.
For example, when a borrower provides a motor vehicle as collateral, they are required to submit the motor vehicle’s logbook to the lender. The lender retains the asset ownership documents until the borrower completes the monthly principal and interest payments for the loan.
In the event that the borrower defaults on the monthly payments, the lender is at liberty to sell the asset pledged as collateral to recover the loan payments that are in default.
Non-Financial vs. Financial Assets
Non-financial and financial assets represent ownership of value, and they represent an economic resource that owners/holders can easily convert into value. Both types of assets are recorded on the balance sheet and are considered when evaluating the actual value of a company.
However, the assets differ based on their characteristics and features. One of the distinguishing characteristics between the two types of assets is how their value is calculated. Non-financial assets, such as motor vehicles, equipment, and machinery, are valued by looking at their physical and tangible characteristics. On the other hand, financial assets are valued based on their contractual claim, and their value can be easily determined in the financial markets.
Another difference between non-financial assets and financial assets is that the former depreciates in value, whereas the latter does not lose value through depreciation. Tangible non-financial assets lose value through depreciation, where the value of the asset is spread over its useful life.
Other non-financial assets, such as land, appreciate in value. In contrast, financial assets are not affected by depreciation but may lose value through changes in market interest rates and fluctuations in stock market prices.
Classification of Financial Assets and Liabilities
Financial instruments comprise the full range of financial contracts made between institutional units. Financial instruments include financial assets and other financial instruments. Financial assets have demonstrable value. Other financial instruments (e.g., financial guarantees, lines of credit, or loan commitments) are contingent or conditional upon the occurrence of uncertain future events. They are outside the financial assets boundary and therefore not included in the monetary and financial statistics
An asset is a store of value, over which ownership rights are enforced and from which their owners may derive economic benefits by holding or using them over a period of time. Financial assets are a subset of economic assets that are financial instruments.
Most financial assets are financial claims arising from contractual relationships entered into when one institutional unit provides funds or other resources to another. These contracts are the basis of creditor/debtor relationships through which asset owners acquire unconditional claims on economic resources of other institutional units. The creditor/debtor relationship provides asset and liability dimensions to a financial instrument. From this a financial claim, and hence a liability, can be defined. There are no nonfinancial liabilities recognized in macroeconomic statistics; thus the term liability necessarily refers to a liability that is financial in nature.1
A financial claim is an asset that typically entitles the creditor to receive funds or other resources from the debtor under the terms of a liability. Each claim is a financial asset that has a corresponding liability.
A liability is established when one unit (the debtor) is obliged, under specific circumstances, to provide funds or other resources to another unit (the creditor). Usually, a liability is established through a legally binding contract that specifies the terms and conditions of the payment(s) to be made and payment according to the contract is unconditional.
Financial assets consist of all financial claims, including shares or other equity in corporations, plus gold bullion held by monetary authorities as a reserve asset. Equity is regarded as a claim; it represents a claim of the owner on the residual value of the entity after the claims of all creditors have been met. Gold bullion included in monetary gold is considered to be a financial asset because of its role as a means of international payments and a store of value for use in reserve assets.2
Legal and Economic Ownership
Two types of ownership can be distinguished in macroeconomic statistics: legal ownership and economic ownership. The legal owner of nonfinancial and financial assets and liabilities is the institutional unit entitled by law and sustainable under the law to claim the associated benefits. The economic owner of nonfinancial and financial assets and liabilities is the institutional unit entitled to claim the benefits associated with their use by virtue of accepting the associated risks.
Every nonfinancial and financial asset and liability has both a legal and an economic owner. In most cases, the economic owner and the legal owner are the same. Where they are not, the legal owner has passed the risk involved in using the resource in an economic activity to the economic owner as well as associated benefits. In monetary and financial statistics, when the expressions “holder(s),” “holding(s),” “ownership,” or “owner” are used, and the legal and economic owners are different, the reference should generally be understood to be to the economic owner.
In general, a change in legal ownership also involves a change in economic ownership. In some cases, however, a change of economic ownership takes place even though the legal ownership remains unchanged (e.g., financial leases). In other cases, there is no change in economic ownership, even though there is a change in legal ownership (e.g., repurchase agreements).
Monetary gold is gold to which the monetary authorities (or others who are subject to the effective control of the monetary authorities) have title and is held as a reserve asset.4 It comprises gold bullion (including gold held in allocated gold accounts) and unallocated gold accounts with nonresidents that give title to claim the delivery of gold. All monetary gold is included in reserve assets or is held by international financial institutions.
For gold bullion, there is no corresponding liability. Except in limited institutional circumstances when reserve assets may be held by other institutions, gold bullion can be a financial asset only for the central bank or central government. Gold bullion takes the form of coins, ingots, or bars with a purity of at least 995 parts per thousand. Gold bullion holdings that are not part of reserve assets are classified as nonfinancial assets.
An allocated gold account provides ownership of a specific piece of gold, whereas an unallocated gold account does not give the holder the title to physical gold but provides a claim against the account operator to deliver gold (see also paragraph 4.44). Both allocated and unallocated gold accounts can be opened by any sector or subsector with a financial corporation (FC) that offers such services.
Allocated gold accounts are classified as monetary gold when held by monetary authorities (or other units authorized by them) as reserve assets, or as a nonfinancial asset when not held as reserve assets. Unallocated gold accounts that give title to claim the delivery of gold are classified as monetary gold when held by monetary authorities (or other units authorized by them) as reserve assets. Unallocated gold account assets not held as reserve assets, and all unallocated gold account liabilities, are classified as deposits in foreign currency. The same principle applies to unallocated accounts for other precious metals.
Nonmonetary gold, which can be in the form of bullion, gold powder, and gold in other unwrought or semi-manufactured forms, or gold coins, may be held as either a store of value or for industrial purposes. In some cases, a central bank may own gold bullion that is not held as a reserve asset and thus should be classified as nonmonetary gold.
Session 3 SO 3 |
Measure and record financial and non-financial data.. |
Learning Outcomes (Assessment Criteria) | · Assets and liabilities in general purpose financial statements are measured and disclosed in accordance with defined measurement and disclosure criteria. · Elements of financial position are measured and disclosed in accordance with defined measurement and disclosure criteria. · Elements of performance in relevant statements are measured and disclosed in accordance with defined measurement and disclosure criteria. · Qualitative information relevant to risk is disclosed in pre-defined timeframes, and related to the environment and human resources. · Non-financial data that is of relevance and importance, is measured and disclosed in accordance with defined measurement and disclosure criteria. |
Measure and record financial and non-financial data.
Elements of financial statements
Financial accounting is the branch of accounting that is concerned with the summary, analysis, and reporting of financial transactions relating to a business.
The end product of Financial accounting involves the preparation of Financial Statements for the users of accounting information.
A financial statement includes the following:
Statement of Financial Accounting Concepts (SFAC) 6 , governed by Generally Accepted Accounting Principles (GAAP), encompasses 10 elements of financial statements which mainly focus on measuring the performance and ascertaining the financial position of the business enterprise. It has embodied the accrual system of accounting in its elements that adhere to the financial statements.
The 10 elements included in the financial statements are as follows:-
The following elements of financial statements are discussed below to have a deep insight into their meanings
Assets are the property or legal rights owned by a business to which money value can be attached. In other words, it is an item of economic value that is expected to yield a benefit in the future. Assets can be classified into:
Tangible Assets are those assets that have physical existence i.e. they can be seen and touched.
Examples of tangible assets are machinery, furniture, building, etc.
Intangible assets are those assets that do not have physical existence i.e. they cannot be touched and seen. Examples of intangible assets are goodwill, patents, trademarks, etc.
iii. Fixed Assets Fixed Assets are those assets that are put to use for more than one accounting period and its benefit is derived over a longer period.
For example, computers, machinery, land, etc.
Current assets are the assets that are readily convertible into cash and generally absorbed within one accounting period.
For example, debtors exist to convert them into cash, bills receivable, etc.
According to IFRS Framework, “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits”. In other words, liability is the amount owed by the business to the proprietor and to the outsiders. Liabilities are generally categorized into 2 broad categories i.e. Current Liabilities and Non-Current Liabilities.
Equity represents an ownership interest in a firm in the form of stock. Being precise in the accounting terms, it is the difference between the value of assets and the cost of liabilities of something owned. It is mainly a residual amount adjusted by the assets against liabilities.
Equity= Assets – Liabilities
It depicts an increase in equity resulting from the transfer of resources in exchange for an ownership interest. It basically describes an owner’s contribution to the firm.
The issue of ownership shares of stock by a company in exchange for cash represents an investment by owners.
It represents a decrease in equity which results from transfer to owners. It determines the owners’ withdrawal from the ownership interest of the firm.
A cash dividend paid by a corporation to its shareholders is an example of distribution to owners.
Revenue is the income that a business earns from its normal business activities. It is an inflow of assets, which result in an increase in owner’s equity.
Exchange of goods and services for money consideration is an example of revenue.
Gain is an increase in owner’s equity from peripheral transactions which are irregular and non-recurrent in nature.
For example, the Sale of machinery for an amount greater than its book value (original cost less depreciation) would result in a gain for an enterprise that is engaged in the business other than that of sale and purchase of machinery.
Expenses are the gross outflows incurred by the business enterprise for generating revenues. An expense is charged to Profit and Loss Account.
Loss is a decrease in owner’s equity from peripherals transactions which are irregular and non-recurrent in nature.
For example, Sale of machinery for an amount lesser than its book value (original cost less depreciation) would result in a gain for an enterprise that is engaged in the business other than that of sale and purchase of machinery.
Comprehensive income is the change in equity of a business enterprise from transactions from non-owner sources. It includes all changes in equity of an enterprise other than those resulting from investments by owners and distributions to owners.
Purposes of the elements of financial statements.
The elements of financial statements serve specific purposes that benefit in financial accounting. Understanding a company’s profit-loss graph, statistical analysis, and economic status is very important to increase the gross output of the business.
Benefits of writing financial statements.
Elements of financial statements also help in getting credits for the business. Financial statements are required for calculating federal tax dues. Thus, they are beneficial when it comes to filling out reports for tax obligations. Financial statements, therefore, help in making an enterprise better and organized.
How Auditors Use Non-Financial Information
Every financial transaction your company records generates nonfinancial data that doesn’t have a dollar value assigned to it. Though auditors may spend most of their time analyzing financial records, nonfinancial data can also help them analyze your business from multiple angles.
Gathering audit evidence
The purpose of an audit is to determine whether your financial statements are “fairly presented in all material respects, compliant with Generally Accepted Accounting Principles (GAAP) and free from material misstatement.” To thoroughly assess these issues, auditors need to expand their procedures beyond the line items recorded in your company’s financial statements.
Nonfinancial information helps auditors understand your business and how it operates. During planning, inquiry, analytics and testing procedures, auditors will be on the lookout for inconsistencies between financial and nonfinancial measures. This information also helps auditors test the accuracy and reasonableness of the amounts recorded on your financial statements.
Looking beyond the numbers
A good starting point is a tour of your facilities to observe how and where the company spends its money. The number of machines operating, the amount of inventory in the warehouse, the number of employees and even the overall morale of your staff can help bring to life the amounts shown in your company’s financial statements.
Auditors also may ask questions during fieldwork to help determine the reasonableness of financial measures. For instance, they may ask you for detailed information about a key vendor when analyzing accounts payable. This might include the vendor’s ownership structure, its location, copies of email communications between company personnel and vendor reps, and the name of the person who selected the vendor. Such information can give the auditor insight into the size of the relationship and whether the timing and magnitude of vendor payments appear accurate and appropriate.
Your auditor may even look outside your company for nonfinancial data. Many websites allow customers and employees to submit reviews of the company. These reviews can provide valuable insight regarding the company’s inner workings. If the reviews uncover consistent themes — such as an unwillingness to honor product guarantees or allegations of illegal business practices — it may signal deep-seated problems that require further analysis.
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