An accountant prepared a statement of financial position for business. In this statement, the equity of the owner was shown next to the liabilities. This confused the owner who argued: ‘My equity is my major asset and so should be shown as asset on the statement of financial position.’ Required: (a) How would you explain this misunderstanding to the owner? (b) “Financial accounting statements tend to reflect past events”. In view of this statement, how can they be of any assistance to a user in making a decision when decisions by their very nature can only be made about future actions?
The business and the owner are different entities. The equity has to be paid backed to the owner and is a liability of the business. Thus, it is shown on the liability side of the balance sheet. It is an asset for him but is a liability for the business.
Financial statements are based on historical information. They help to analyze trends in business. Cost saving in expenses can be thought of looking at the expenses. Revenues can be looked at to see effects of advertising and marketing.
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