BALANCE SHEET

Accounting ASW

Summer 2007

Assets = Liabilities + Owners’ Equity

• Net Worth

• Explains the components of net worth

Reason for mis-valuation

• Accounting omits many assets

• Accounting mis-values many assets

• FASB/IASB know and do it intentionally

Asset Definition

• Probable net future cash inflow

• Currently right to it (often title)

• Past transaction provided right

• Future benefits reasonably quantifiable

Are these recognized as assets?

• Cash, accounts receivable and PP&E?

• Yes, recognized as assets

• Intangibles

- patents/R & D,

- trademarks/advertising

- goodwill?

• Recognized only if purchased externally

• Executory contracts

- situations in which contracts have been signed but neither party has acted

- e.g., purchase contracts, rental agreements, etc.

• Generally not

• Employees

• Never

Asset Valuation

• Most assets are value based on historical cost (e.g., inventory, PP&E, land)

- Initially at acquisition cost

- Inclusive of the cost of putting in place--e.g., labor, taxes, transportation, etc.

• PP&E is reduced by: - depreciation of normal use

- impairment if value falls below book

• Inventory reduced to lower of cost or market

• Accounts receivable are reduced for estimated bad debts

• A few assets are valued at fair market value

- e.g., some debt and equity securities and financial instruments

- increasingly common, especially with financial instruments

- remains controversial

Asset Classification (US)

• Current assets—one year (or operating cycle) until cash

• Noncurrent assets—longer term

– E.g., Strategic investments in other companies;

property, plant and equipment; intangible assets

• Problem 2.17

Problem 2.17: Is there an asset created if? Rents space for five years, starting next month. Pays $125K for 1st year rent & $130K deposit. Commits to paying $500K later for last 4 years.

Spends $10K on partitions, $6.5K on paint & 20K on carpet.

Buys display counter for $30K less 2% discount; pays $1.2K to transport and $0.8K to install.

Hires store manager at $60K.

Spends $1.5K on this month’s advertising.

Buys $160K of inventory; pays for $120K with 2% discount; $12K is returned, rest is still owed.

Liability Definition

• Probable net future cash (or service/goods outflow)

• Unavoidable obligation to pay it

• Created by past transaction or exchange

• Amount (and time) can be reasonably estimated

Are these recognized as liabilities?

• Accounts payable, long-term debt? • Yes, recognized as liabilities

• Contingencies and litigation? • Rarely; if probable and reasonably estimable

• Executory contracts? • No?

• Employees?

Liability Classification

• Current liabilities - due within a year (or operating cycle) - includes the current portion of long-

term debt • Noncurrent liabilities—longer term

- E.g., non-current long term debt; weird

liabilities like deferred taxes, pension

liabilities, etc.

Liability Valuation

• Expected cash outflow for most current liabilities

- e.g., accounts. payable, salaries payable, etc.

- not worth the effort of discounting• Discounted present value of future cash

outflow for long-term debt (including current portion)

- typically clear from amount received at issuance

• Problem 2.18

Problem 2.18: Is there a liability created if?

Sign contract to have landscaping done next year for $7.5K.

Receive $72 for magazine subscription starting next year.

Receive $2M toward a $10M bridge to be started next year.

Issue common stock for $7.6M.

Receive $100K bank loan, 6% interest to be paid.

Sign a contract to purchase at least $60K of supplies next year.

Place a $15K order on the above contract.

Owners’ Equity

• Residual (assets - liabilities)

Owners’ Equity Classification

• Contributed Capital • Par value (shares outstanding times

par value per share)--arbitrary • Capital in excess of par (proceeds

minus par value)

• Retained earnings (cumulative earnings net of dividends)

• Other--foreign currency translation etc.

Basic Journal Entries

• Debits: on the left

• Credits: on the right

• Assets increase with debits

• Liabilities increase with credits

• Debits=Credits implies Assets=Liabilities + Owners’ Equity

Buy inventory for cash

Buy inventory on credit

Issue stock for cash

Pay off accounts payable

Sell inventory at cost

Problem 2.27, 2.29

Problem 2.27: What journal entries for: 1. Issue stock for $30K.

2. Borrow $5K from bank, 6% future interest.

3. Rent a building and prepay $12K.

4. Acquire equipment for cash of $8K.

5. Acquire $25K of inventory, $12K for cash,

the rest on credit.

6. Sign a contract to provide $2K of groceries per week, receive $4K advance.

7. Buy insurance starting next year for $1.2K cash.

8. Pay $600 in advance for ads for next month.

9. Place a supplies order for $35K to be delivered

and paid for next month.

Problem 2.29: Prepare balance sheet, new co. 1. Issue stock for $800K.

2. Acquire land for $50K, building for $450K.

3. Purchase inventory on account for $280K.

4. Pay for $250K in 3, with 2% discount.

5. Pay $12K for one year insurance, starting next year.

6. Borrow $300K from bank on 12/31.

7. Acquire equipment on 12/31 for $80K 6% note.

Contra Accounts

• Accumulate reductions in accounts

• Often used to separate historical cost frombook value

• Accumulated Depreciation - Contra-asset offsetting PP&E at cost - Credit balance

• Allowed for Doubtful Accounts - Contra to accounts receivable