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Chapter Nine
Lecture Notes
Taking Stock of Where You Are:
The Balance Sheet
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Managerial and
Financial Accounting

Managerial Accounting: Internal Focus.
–
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Plan
Implement
Control
Financial Accounting: External Focus.
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Record events or transactions.
Report financial position and results of operations.
The Financial Statements
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Statement of Financial Position (Balance Sheet) - a snapshot
of the resources, obligations, and worth of an organization at a
specific point in time.
Activity Statement (Operating or Income Statement) measures the cumulative resource inflows and outflows for an
organization over some specified period of time. It is the
reporting equivalent of an operating budget.
Cash Flow Statement - measures the cumulative cash inflows
and outflows for an organization over some specified period of
time. It is the reporting equivalent of a cash budget.
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Financial Statement Concepts
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Generally Accepted Accounting Principles from the FASB
(not-for-profits) or the GASB (governments) guide the preparation of
financial statements.
Entity Concept requires that you define the organizational
component for which you are trying to account.
Money Denominator Convention requires that all items included
on the financial statements be measurable in dollar terms.
Objectivity Principle requires that values be based on an objective
valuation of resources. When there is a dispute over value, cost is used.
Original (Historical) Cost – assets are recorded at the amount paid for
them. 4
More Financial Statement Concepts
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Conservatism says that you should anticipate and report losses
but not gains.
Going Concern Concept assumes that the organization will
continue in operation.
Materiality says that reporting only needs to contain the level of
detail and accuracy necessary for decision making. Financial
reports do not need to be exactly accurate.
Accrual Concept states that revenues are recorded when the
organization has earned them and expenses are recorded when
resources are used to generate revenues.
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The Fundamental
Accounting Equation
Claims by
Outsiders
Resources
Residual
Assets
Owned by
Owners
Assets = Liabilities + Equity
or
Sources of
Resources
Assets - Liabilities = Equity
What you own -
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What you owe = What you are worth
Equation must always be in balance!
Statement of Financial Position
(The Balance Sheet)

Balance sheet reports:
- what an organization owns (Assets),
- what it owes to outsiders (Liabilities), and
- the portion of the organization's assets owned by its owners. Called
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Owner's Equity, Partners' Equity, Net Worth, or
Stockholders’ Equity (for-profit organizations).
–
Net Assets or Fund Balance (not-for-profit and governments).
- at a specific point in time. For example, at the end of the
organization's Fiscal Year.
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A Personal Balance Sheet
Ms. Jane Frost
Balance Sheet
As of December 31, 2011
Assets
Liabilities & Net Worth
Liabilities
Cash
$ 1,000
Car
Car Loan
12,000 Total Liabilities
Net Worth
Total Assets
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$13,000 Liabilities & Net Worth
$ 3,000
$ 3,000
$10,000
$13,000
Assets
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Assets on the balance sheet are divided into current or short-term
(those that are cash or are expected to become cash or will be
used up within twelve months) and long-term (those that will not).
Short-Term or Current Assets are listed in order of declining
liquidity and normally include:
-
cash,
marketable securities,
accounts receivable,
inventory, and
prepaid expenses
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Meals for the Homeless
Balance Sheet
ASSETS
LIABILITIES & NET ASSETS
Current Assets
Cash
Marketable Securities
Accounts Receivable, Net
Liabilities
$ 1,000
Current Liabilities
3,000
Wages Payable
55,000
$ 2,000
Accounts Payable
2,000
Inventory
2,000
Notes Payable
6,000
Prepaid Expenses
1,000
Current Portion - Mortgage Payable
4,000
Total Current Assets
$62,000
Long-Term Assets
Equipment, Net
Investments
Total Long-Term Assets
TOTAL ASSETS
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$ 14,000
Long-Term Liabilities
Fixed Assets
Property
Total Current Liabilities
Mortgage Payable
$ 40,000
Total Long-Term Liabilities
$ 12,000
$ 12,000
35,000
8,000
TOTAL LIABILITIES
$ 26,000
$ 83,000
NET ASSETS
119,000
$145,000
TOTAL LIABILITIES & NET ASSETS
$145,000
Marketable Securities
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Marketable securities include equity and debt instruments
that can be bought and sold in public and private markets.
The values of Marketable Securities are reported by
governments and not-for-profit organizations at fair market
value.
For-profit organizations use fair market value for
reporting most of their marketable securities.
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Meals for the Homeless
Balance Sheet
ASSETS
LIABILITIES & NET ASSETS
Current Assets
Cash
Marketable Securities
Accounts Receivable, Net
Liabilities
$ 1,000
Current Liabilities
3,000
Wages Payable
55,000
$ 2,000
Accounts Payable
2,000
Inventory
2,000
Notes Payable
6,000
Prepaid Expenses
1,000
Current Portion - Mortgage Payable
4,000
Total Current Assets
$62,000
Long-Term Assets
Equipment, Net
Investments
Total Long-Term Assets
TOTAL ASSETS
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$ 14,000
Long-Term Liabilities
Fixed Assets
Property
Total Current Liabilities
Mortgage Payable
$ 40,000
Total Long-Term Liabilities
$ 12,000
$ 12,000
35,000
8,000
TOTAL LIABILITIES
$ 26,000
$ 83,000
NET ASSETS
119,000
$145,000
TOTAL LIABILITIES & NET ASSETS
$145,000
Long-Term Assets
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Long-Term Assets are generally divided into three categories:
- Fixed Assets, which include:
– property (land) usually recorded at cost,
– plant (buildings) originally recorded at cost and later reported
at net book value, and
– equipment originally recorded at cost and later reported
at net book value.
- Investments, and
- Intangibles.
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Meals for the Homeless
Balance Sheet
ASSETS
LIABILITIES & NET ASSETS
Current Assets
Cash
Marketable Securities
Accounts Receivable Net
Liabilities
$ 1,000
Current Liabilities
3,000
Wages Payable
55,000
$ 2,000
Accounts Payable
2,000
Inventory
2,000
Notes Payable
6,000
Prepaid Expenses
1,000
Current Portion - Mortgage Payable
4,000
Total Current Assets
$62,000
Long-Term Assets
Equipment, Net
Investments
Total Long-Term Assets
TOTAL ASSETS
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$ 14,000
Long-Term Liabilities
Fixed Assets
Property, Net
Total Current Liabilities
Mortgage Payable
$ 40,000
Total Long-Term Liabilities
$ 12,000
$ 12,000
35,000
8,000
TOTAL LIABILITIES
$ 26,000
$ 83,000
NET ASSETS
119,000
$145,000
TOTAL LIABILITIES & NET ASSETS
$145,000
Plant and Equipment
on the Balance Sheet
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Recorded at cost when acquired.
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Reported net of accumulated depreciation on the balance sheet.
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Suppose an organization buys a van for $30,000 and expects to
use it for five years and sell it for $5,000. Assuming that the van
will be used up evenly over the five years, how would its value
appear on the balance sheet at the end of two years?
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A Net Book Value Example
Record the Van at Cost $30,000
Subtract two years of depreciation
[($30,000 - $5,000 salvage)/5 yr life] * 2 = $10,000
Net Book Value =
$30,000 cost - $10,000 Accum. Deprec. = $20,000
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Fixed Assets on the Balance Sheet
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All three values - cost, accumulated depreciation, and net book value
are shown on the balance sheet or in notes that accompany the financial
statements. Why?
Museum A
Museum B
Net Fixed Assets or
Net Book Value
$ 1,000,000
$ 1,000,000
PP&E at cost
$ 40,000,000
$ 2,000,000
Accumulated Depreciation
Net Book Value
(39,000,000)
$ 1,000,000
Are these two museums really similar or different?
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(1,000,000)
$ 1,000,000
Recognizing Asset Transactions
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Financial events are recorded at the time of Recognition.
Asset transactions are recognized when:
- the assets are owned by the organization,
- the assets have a monetary value,
- that monetary value can be objectively determined.
Which of the following should be recognized as assets?
- the amount due on a bill sent to a client?
- an LCD computer projector?
- a fundraising mailing list developed in an organization?
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Liabilities
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Liabilities are categorized as short term and long term depending
on when they are due for payment.
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Short term usually means coming due in one year or less
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Short-term liabilities generally consist of:
- specific "payables" which are typically due within thirty days,
- wages or salary payable,
- accounts payable,
- short term notes payable – i.e., short-term loans, and
- the portion of long-term debt coming due this year
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Meals for the Homeless
Balance Sheet
ASSETS
LIABILITIES & NET ASSETS
Current Assets
Cash
Liabilities
$ 1,000
Marketable Securities
Accounts Receivable, Net
3,000
55,000
Current Liabilities
Wages Payable
$ 2,000
Accounts Payable
2,000
Inventory
2,000
Notes Payable
6,000
Prepaid Expenses
1,000
Current Portion - Mortgage Payable
4,000
Total Current Assets
$62,000
Long-Term Assets
Equipment, Net
Investments
Total Long-Term Assets
TOTAL ASSETS
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$ 14,000
Long-Term Liabilities
Fixed Assets
Property
Total Current Liabilities
Mortgage Payable
$ 40,000
Total Long-Term Liabilities
$ 12,000
$ 12,000
35,000
8,000
TOTAL LIABILITIES
$ 26,000
$ 83,000
NET ASSETS
119,000
$145,000
TOTAL LIABILITIES & NET ASSETS
$145,000
Long-Term Liabilities
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Long-Term Liabilities are recorded at the Present Value of the
required future payments. They include:
- Long-Term Debt:
– Capital Leases
– Long-Term Unsecured Loans
– Long-Term Notes Payable
– Mortgages Payable
– Bonds Payable
- Pension Liabilities, and
- Contingent Liabilities.
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Meals for the Homeless
Balance Sheet
ASSETS
LIABILITIES & NET ASSETS
Current Assets
Cash
Marketable Securities
Accounts Receivable, Net
Liabilities
$ 1,000
Current Liabilities
3,000
Wages Payable
55,000
$ 2,000
Accounts Payable
2,000
Inventory
2,000
Notes Payable
6,000
Prepaid Expenses
1,000
Current Portion - Mortgage Payable
4,000
Total Current Assets
$62,000
Long-Term Assets
Equipment, Net
Investments
Total Long-Term Assets
TOTAL ASSETS
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$ 14,000
Long-Term Liabilities
Fixed Assets
Property
Total Current Liabilities
Mortgage Payable
$ 40,000
Total Long-Term Liabilities
$ 12,000
$ 12,000
35,000
8,000
TOTAL LIABILITIES
$ 26,000
$ 83,000
NET ASSETS
119,000
$145,000
TOTAL LIABILITIES & NET ASSETS
$145,000
Liability Recognition
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Liabilities are recognized when:
 they are legally owed,
 have to be paid, and
 the amount to be paid can be measured objectively.
Which of the following should be recognized as a liability?
 a bill received from a vendor?
 wages that are due to a worker?
 a $5 million lawsuit filed against an organization?
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Net Asset Categories
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In not-for-profit organizations, Net Worth is called "Net Assets" and is
broken down into three categories.
- Unrestricted Net Assets, which have not been restricted by donors
- Temporarily Restricted Net Assets, the use of which has been
restricted by donors.
- Permanently Restricted Net Assets, which are restricted in
perpetuity.
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Balance Sheet
with Net Asset Categories
ASSETS
LIABILITIES AND NET ASSETS
Current Assets
Liabilities
Cash
$ 52,000
Accounts Receivable
Inventory
18,000
5,000
Prepaid Insurance
Total Current Assets
0
$ 75,000
Current Liabilities
Accounts Payable
Wages Payable
Total Current Liabilities
Total Long-Term Liabilities
Fixed Assets
Total Liabilities
Property and Equipment-Net
Total Long-Term Assets
Total Assets
$240,000
$240,000
$315,000
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7,000
30,000
$ 37,000
Long-Term Liabilities
Mortgage Payable
Long-Term Assets
$
$140,000
$140,000
$177,000
Net Assets
Unrestricted
$113,000
Temporarily Restricted
15,000
Permanently Restricted
10,000
Total Net Assets
$138,000
Total Liabilities and Net Assets
$315,000
Recording Financial Information
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A financial event is one that affects the fundamental
accounting equation by changing any of its components:
Assets = Liabilities + Net Assets
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A journal is a chronological listing of every financial event
that occurs in an organization.
Every type of asset, liability, revenue, or expense is referred
to as an account. Organizations may have as many accounts
as they need.
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A Sample Transaction
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Suppose HOS buys inventory for $3,000. We could just add it to
assets. But, that puts the Fundamental Equation out of balance.
Assets
+$3,000

=
=
Liabilities
no change
We have not "paid" for the supplies. Suppose the seller sent
HOS a bill. We would record the full transaction as:
Assets =
Liabilities
Inventory
Accounts Payable
+ $3,000 =
+ $3,000

+ Net Assets
+ no change
+ Net Assets
+ no change
To record a financial event, at least two elements of the
fundamental equation must change!
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A One-Sided Change Example
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Not every financial event (transaction) results in changes to
both sides of the fundamental equation. Suppose HOS paid
for the inventory in cash. Then the transaction would have
been recorded as follows:
Assets
Inventory
+ $3,000

Cash
- $3,000
= Liabilities
+ Net Assets
= no change + no change
The fundamental equation is still in balance. But, all of the
changes occurred on the left side of the equation!
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Recording Transactions

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The first step in recording a transaction is determining what has
happened and what accounts will be impacted.
Suppose near the end of the year, HOS buys a one-year insurance
policy for $100 and pays for the policy in cash. Two things have
happened:
- Cash has gone down by $100.
- HOS owns a new $100 asset called "prepaid insurance."
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Here's the way the transaction would be recorded:
Assets
P/I
Cash
+ $100
- $100
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= Liabilities
+ Net Assets
= no change
+ no change
Another Example

HOS mails a check to its bedpan supplier for $2,000 to pay part
of the $7,000 it owed them at the start of the year. Two things
have happened:
- Cash has gone down by $2,000.
- HOS's accounts payable have decreased by $2,000.

Here's the way the transaction would be recorded:
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Assets
=
Liabilities
+ Net Assets
Cash
- $2,000
= Accounts Payable
=
- $2,000
+ no change
Collection Example

HOS receives $12,000 from customers. This was owed to
HOS for care provided during the previous year.
- Cash has gone up by $12,000.
- HOS's accounts receivable have decreased by $12,000.

Here's the way the transaction would be recorded:
Assets
Cash
+ $12,000
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= Liabilities + Net Assets
Accounts Receivable
- $12,000
= No change on right side.
Generating a Balance Sheet

Generating a balance sheet involves:
- Beginning with the starting balance sheet,
- Recording all of the transactions for the period,
- Adding the impact of the transactions to the starting
balance sheet,
- Calculating the ending balances for all accounts
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The Starting Balance Sheet
ASSETS
LIABILITIES AND NET ASSETS
Current Assets
Liabilities
Cash
$ 52,000
Accounts Receivable
Inventory
18,000
5,000
Prepaid Insurance
Total Current Assets
0
$ 75,000
Current Liabilities
Accounts Payable
Wages Payable
Total Current Liabilities
Total Long-Term Liabilities
Fixed Assets
Total Liabilities
Property and Equipment, Net
Total Long-Term Assets
Total Assets
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7,000
30,000
$ 37,000
Long-Term Liabilities
Mortgage Payable
Long-Term Assets
$
$140,000
$140,000
$177,000
$240,000
$240,000
Total Net Assets
$315,000
Total Liabilities and Net Assets
138,000
$315,000
Transactions Work Sheet
ASSETS
Cash
Beginning
Balance
$52,000
Accounts
Receivable
$18,000
Buy
Inventory
Pay for
Fire Ins.
Pay for
Inventory
Receive
Payment
Ending
Balance
LIABILITIES
Inventory
$5,000
Ppd.
Ins.
$ 0
Plant &
Equipment
$240,000
3,000
(100)
Accounts
Payable
$7,000
Wages
Payable
& NET ASSETS
Mortgage
Payable
Net
Assets
$30,000
$140,000
$138,000
3,000
100
(2,000)
(2,000)
12,000
(12,000)
_____
____
_______
_____
______
______
______
$61,900
$ 6,000
$8,000
$100
$240,000
$8,000
$30,000
$140,000
$138,000
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The Ending Balance Sheet
ASSETS
LIABILITIES AND NET ASSETS
Current Assets
Liabilities
Cash
$ 61,900
Current Liabilities
Accounts Receivable
6,000
Accounts Payable
Inventory
8,000
Wages Payable
Prepaid Insurance
Total Current Assets
100
$ 76,000
Total Current Liabilities
Total Long-Term Liabilities
Fixed Assets
Total Liabilities
Property and Equipment, Net
Total Long-Term Assets
Total Assets
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8,000
30,000
$ 38,000
Long-Term Liabilities
Mortgage Payable
Long-Term Assets
$
$140,000
$140,000
$178,000
$240,000
$240,000
Total Net Assets
$316,000
Total Liabilities and Net Assets
138,000
$316,000