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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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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 Liabilities
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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Long-Term Liabilities
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
Stockholders’ Equity
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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Stockholders’ Equity
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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Stockholders’ Equity
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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Stockholders’ Equity
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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Accumulated OtherComprehensive Income
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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Accumulated OtherComprehensive Income
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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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Financial Accounting, 7e Stice/Stice, 2006 © Thomson
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