The Balance Sheet StatementLearning Objectives

1.How balance sheet accounts are measured, classified and presented.

2.How balance sheet information is used.

3.Balance sheet terminology and format.4.How footnotes aid to the understanding of the firm’s accounting policies, contingent liabilities, subsequent events, and related-party transactions

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The Accounting Equation

Assets = Liabilities + Equity

Shareholders’ Equity:

What’s left of the company’s assets

after paying off liabilities. It also referred to as net assets.

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Balance sheet classification:Overview

• Current assets• Property, plant and equipment• Investments• Other assets

• Current liabilities• Long-term debt• Other liabilities

• Preferred and common stock• Additional paid-in capital• Retained earnings

ASSETS LIABILITIES EQUITY= +

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Elements of the balance sheet

• Probable future economic benefits• Obtained from past transactions or events

• Probable future sacrifices of economic benefits• Arising from present obligations• To transfer assets or provide services in the future• As a result of past transactions or events

• The residual interest in net assets.

ASSETS LIABILITIES EQUITY= +

How the money is invested Where the money came from

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The Balance Sheet

This measurement technique is limited Consequently, a variety of measurement techniques are

used to measure the elements of the balance sheetHistorical (Historical cost)

Current oriented (Current value)

Future oriented (Expected realizable value)

Asset Valuation

Asset

Cash

Accounts receivable

Marketable securities

Inventory

Investments

Property, plant and equipment

Measurement basis

Current value

Expected future value

Fair value

Current or past value

Fair value or amortized cost

Depreciated past value

Balance sheet Classification and Account Measurement - Current assets

Amortized cost or current market value

Net realizable value

Lower of cost or current market value

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Assets – classification and measurement

Resources with future economic benefit to a business entity as a result of a past transaction.

Current Assets: cash and other assets that are reasonably expected to be realized in cash or sold, or consumed during a normal operating cycle or one year, whichever is longer

Examples: Cash and cash equivalents, short-term investments (reported at the fair value), receivables (estimated amount collectible), inventory (LCM), prepaid expenses, etc.

Balance Sheet Classification and Account Measurement -PPE, Investments and Intangibles

Historical cost minus accumulated depreciation except that fair market value is used when “impaired”

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Assets (contd.)

Long-term Investments: Comprise of the following

Securities (i.e., bonds, stock, long-term notes)

Fixed assets (i.e., land, building)

Special funds (i.e., pension fund, bond fund)

Nonconsolidated subsidiaries or affiliated companies

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Assets (contd.) Property, Plant, Equipment (i.e., building,

Land, Machinery and equipment, capital leases): assets used in firms’ operations and meet the following criteria:

1. Economic life > 1 year;

2. Acquired for use in operation;

3. Not for resale to customers;

4. $ is material. (materiality)

Depreciation will be applied except for land.

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Assets (contd.) Intangible Assets: assets with no

physical substance but have value based on rights or privileges that belong to the owner (i.e., goodwill, patents, franchises, trademarks,…).

Amortization for limited life intangibles (i.e., patents, franchises) and impairment test for indefinite-life intangibles (i.e., goodwill).

Balance Sheet Classification and Measurement - Liabilities

Amount due at maturity

Historical cost

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Discounted present value

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Liabilities

Legal obligations required future payments of assets or services as a result of a business entity’s past transactions or events.

A. Current Liabilities

B. Long-term Liabilities

C. Other Liabilities

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A. Current Liabilities

Obligations must be fulfilled in one year or one operating cycle, whichever is longer. (will require the use of current assets or the creation of current liability) (i.e., A/P, N/P, accrual payable, unearned revenue, income tax payable, current portion of L-T debt)

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Contingent Liabilities

Obligations may arise because of the occurrence or not occurrence of future event(s). (i.e., warranty obligations)

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B. Long-Term Liabilities

Obligations are not due in next year or next operating cycle, whichever is longer. (i.e., bonds payable, pension liability)

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C. Other Liabilities

Long-term advances from customers, deferred income taxes.

Balance Sheet Classification and Account Measurement -Stockholders’ equity

Historical par value

Historical cost

Combination of different measurement bases

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b. Accumulated Other Comprehensive Income

Increase of assets without outflows of assets, increase of liabilities, increase of income or issuance of common stock (i.e.,(+) increase in market value of securities-available-for-sale (+ or -), gains or losses of foreign currency adjustments, etc.)

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c. Retained Earnings

Net income not distributed to stockholders

Balance sheet information

LIABILITIES+

EQUITY

ASSETS

1. Rates of return

2. Capital structure

3. Liquidity

4. Solvency

5. Flexibility

ROA and ROCE

Debt vs. Equity

Cash conversion

Ability to pay debt

Operating and financial

Helps

assess

Balance Sheet

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1. Rate of Return Ratios

ROA (return on assets) and ROCE (return on common equity) ratios: Evaluate operating efficiency and profitability.ROA = Net operating profit after taxes (NOPAT) /

Average assets

ROCE =(Net income – Preferred dividends) / Average

common shareholders’ equity

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Financial statement footnotes Footnotes are an integral part of

companies’ financial reports. These “notes” help users better

understand and interpret the numbers presented in the body of the financial statements.

Three important notes:1.Summary of significant accounting

policies.2.Subsequent event disclosures.3.Related party transactions 4-2424

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Limitations of the Balance Sheet 1. Historical costs reporting for most of assets and liabilities.

2. Estimations involved in the value of some assets and liabilities (i.e., the net realizable value of accounts receivable and the cost of warranty).

3. the omission of some valuable items such as goodwill of the company.

4. Off-balance sheet liabilities.

Summary1. The balance sheet shows the assets

owned by a company at a given point in time, and how those assets are financed (debt vs. equity).

2. Be alert for differences in balance sheet measurement bases, account titles, and statement format.

3. Financial statement footnotes provide important information..

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