Chapter 4 The Balance Sheet. Individual Balance Sheet Accounts.

Chapter 4The

BalanceSheet

Individual BalanceSheet Accounts

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Financial Accounting, 7e Stice/Stice, 2006 © Thomson

Current Assets

Current assets include assets that are expected to be used within one year or the operating cycle, if longer

– The operating cycle involves the use of cash to buy inventories, selling the inventory to create accounts receivable, and the collection of those receivables

– In practice, one year is the common definition

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The Operating Cycle

CashCash

InventoriesInventoriesReceivablesReceivables

Collections Purchases

Sales

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Current Assets

Cash includes coins and currency on hand; bank accounts; and short-term securitiesAccounts receivable are amounts owed by customers

– An estimate of uncollectible accounts is deducted

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Current Assets

Inventory represents goods held for sale in the normal course of business Prepaid expenses are payments in advance for operating expenses, e.g., insurance and rentInvestment securities are publicly-traded stocks and bonds held with the intent to sell within a year

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Current Assets

Current assets are listed on the balance sheet in the order of their liquidity, with the most liquid assets listed first

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Long-Term Assets

Expected to last longer than one yearCommon categories include

– Investments– Property, plant, and equipment– Intangible assets– Other assets

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Long-Term Assets

Long-term investments include ownership of stocks and bonds to

– Exercise influence over other companies (stocks)

– Earn income from•Interest (bonds)•Dividends (stocks)

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Long-Term Assets

Property, plant, and equipment (PP&E) are fixed assets that benefit more than one accounting period

– They include land, buildings, machinery, tools, furniture, and vehicles

– Accumulated depreciation reflects the wear and tear since the original purchase and decreases PP&E

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Long-Term Assets

Intangible assets have no physical existence, but have some intrinsic value, generally from contract rights

– Patents– Trademarks– Copyrights– Franchises– Goodwill

• only recorded when one company buys another and pays more than the fair value of the identifiable assets

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Long-Term Assets

The other assets category contains long-term assets not reportable under the previous categories

– e.g., a deferred tax asset occurs when a loss or expense is recognized for financial reporting purposes, but will be deducted on the tax return in a later year

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Current Liabilities

Obligations expected to be paid out of current assets within one year

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Current Liabilities

Accounts payable are created when a company buys merchandise or supplies on creditAccrued liabilities represent expenses incurred (e.g., salaries, interest, taxes), but not yet paid

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Current Liabilities

Short-term loans payable are formal, interest-bearing loans expected to be paid within one yearThe current portion of long-term debt is the portion of these liabilities expected to be paid within one year from the balance sheet date

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Current Liabilities

Unearned revenue is the obligation to provide services to customers who have paid in advance

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Long-Term Liabilities

Long-term liabilities are obligations not expected to be paid or otherwise satisfied within one year

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Long-term debt includes long-term notes, bonds, and mortgagesCapital lease obligations represent leases of plant assets which are equivalent to debt-financed purchases

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Deferred tax liability: income tax expected to be paid in future years on income already reported on the income statementPension obligations and other post-retirement obligations relate to a company’s promise to pay benefits after the employees’ retirement

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Stockholders’ Equity

The residual interest in a corporationThe owners’ paid-in capital can take the form of common stock or preferred stock

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Common stockholders– Have the most risk– Have the potential to reap the

greatest returnCommon stock amounts are reported at

– Par value (the amount printed on the certificates)

– Additional paid-in capital (the amount paid above par)

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Preferred stockholders– Usually have a fixed return on their

investment– Have fewer ownership rights than

common stockholders•Typically do not have voting rights

– Have lower risk than common stockholders

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Retained earnings is the cumulative amount of profit that has not been distributed to stockholders as dividendsIncreased by

– net income

Decreased by– net losses– dividends

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Treasury stock: the company’s own shares that have been repurchased

– The amount of treasury stock is subtracted from stockholders’ equity

A company purchases treasury stock to

– Show confidence in the value of the shares

– Distribute cash to stockholders

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Accumulated OtherComprehensive Income

Foreign currency translation adjustments

– Arise from the change in equity of foreign subsidiaries as a result of changes in foreign currency exchange rates

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Unrealized gains and losses on available-for-sale-securities

– Unrealized gains and losses are fluctuations in the market prices of securities before they are sold

– Available-for-sale-securities are those a company does not intend to sell in the short-run

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Unrealized gains and losses on derivatives

– Derivatives are financial instruments that derive their value from the movement of a price, an exchange rate, an interest rate, or an interest rate associated with another item

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Form of the Balance Sheet

Side-by-side form– Assets on the left-hand side– Liabilities and owners’ equity on

the right-hand side

Columnar form– Assets, liabilities, and owners’

equity presented vertically

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Form of the Balance Sheet

Current assets and current liabilities are listed by their liquidityCurrent assets and current liabilities are normally listed before long-term assets and liabilitiesBalance sheets are generally presented in a comparative format

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Foreign Balance Sheets

•PP&E is frequently listed first

•Current assets and current liabilities are frequently netted together as working capital

Recognition andValuation

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Recognition

Recognition: an amount is recorded and reported in the financial statementsAs an alternative, disclosure conveys financial information in the form of narrative notes

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Probable future sacrifice of economic benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events

BALANCE SHEET

ASSET LIABILITY

EQUITYResidual interest in the assets of an entity that remains after deducting its liabilities

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Valuation

Valuation is the process of assigning a value to an item once it is determined it should be recognized in the financial statements The value should be

– Reliable: Independent parties can agree on the value and

– Relevant: Reflects information that financial statement users care about

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Valuation

Historical cost is an extremely reliable numberMarket value is an extremely relevant numberThe balance sheet reflects a mixture of different valuation methods

– Market value is used when it is both relevant and reliable, e.g., investment securities

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Transaction Analysis

The process of determining how an economic event impacts the financial statementsA spreadsheet can be used to analyze the transactions of Veda Landscape Solutions based on the accounting equation:

Assets = Liabilities + Owners Equity

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1) Veda invests $700,000 of her own cash in the business in exchange for all 10,000 shares of common stock.

Tx Cash InventoryPrepaid

Ins. Land Buildings Equip.Accounts Payable

Loan Payable

Mortgage Payable

Paid In Capital

1 700,000 700,0002 300,000 300,0003 (100,000) 50,000 400,000 350,0004 (650,000) 650,0005 [no transaction]6 [no transaction]7 (10,000) 90,000 80,0008 (15,000) 15,000

225,000 90,000 15,000 50,000 400,000 650,000 80,000 300,000 350,000 700,000

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Assets = Liabilities + Equity

Tx Cash InventoryPrepaid

Ins. Land Buildings Equip.Accounts Payable

Loan Payable

Mortgage Payable

Paid In Capital

1 700,000 700,0002 300,000 300,0003 (100,000) 50,000 400,000 350,0004 (650,000) 650,0005 [no transaction]6 [no transaction]7 (10,000) 90,000 80,0008 (15,000) 15,000

225,000 90,000 15,000 50,000 400,000 650,000 80,000 300,000 350,000 700,000

Total assets$1,430,000

Total liabil & equity$1,430,000

Use this information to prepare the balance sheet

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Current Assets:Cash $225,000Inventory 90,000Prepaid Insurance 15,000

Total Current Assets $330,000Long-term Assets

Land 50,000Building 400,000Equipment 650,000

Total Assets $1,430,000

Current LiabilitesAccounts Payable $80,000

Long-term LiabilitiesBank loan payable 300,000Mortgage payable 350,000

Total Liabilities $730,000Paid-in Capital 700,000

Total liabilities and stockholders' equity $1,430,000

Veda Landscape SolutionsBalance Sheet

January 1, 2006

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Asset mix is the proportion of total assets in each asset category

– Generally differs by industry•Retailers have lots of inventory•Manufacturers have lots of PP&E•Banks have lots of loans receivable

Asset and Financing Mix

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Financing mix is the percentage of financing in each of two categories:

– Liabilities– Equity

It is reflective of management financing decisions rather than industry

Asset and Financing Mix

Chapter 4 The Balance Sheet. Individual Balance Sheet Accounts.

Documents

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