Transcript The Balance Sheet

This week its Accounting and Beyond
Session 1
Tuesday
Financial Statements/Expenses/Revenues
Wednesday
Thursday
Friday
Session 2
Accounting Cycle & Accounts
The Balance Sheet
The Income Statement
The Cash Flow Statement
Tools & Techniques
Tax Havens
Exam
1-1
The Balance Sheet
 Also called the statement of condition or the
statement of financial position
 Shows the financial condition of a company
on a particular date
 Summarizes what the firms owns and what
the firm owes to outsiders and to internal
owners
2-2
Financial Condition
Assets Liabilities  Stockholders' equity
 Assets are what the firm owns.
 Liabilities are what the firm owes to
outsiders.
 Stockholders’ equity is what the firm owes to
internal owners.
2-3
Financial Condition
Consolidation
 Parent company owns more than 50% of
voting stock.
 Financial statements are combined.
2-4
Financial Condition
Balance Sheet Date
 The date the balance sheet is prepared
 Could be the end of the calendar year, fiscal
year, quarter, etc.
2-5
Financial Condition
Comparative Data
 SEC requires two-year audited balance
sheets.
 Provides a reference point for determining
changes in financial position
2-6
Financial Condition
Common-Size Balance Sheet
 Expresses each item on the balance sheet as a
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percentage of total assets
Reveals the composition of assets
Form of vertical ratio analysis
Useful for evaluating trends within a firm
Allows for making industry comparisons
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Financial Condition
2-8
Assets
2-9
Assets
The allowance account for Sage Inc. represents
approximately 5% of accounts receivable:
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Assets
Sage Inc.
2-11
Assets
2-12
Assets
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Assets
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Assets
Example – A new company in its first
year of operations purchases five products
for sale in the order and at the prices
shown. The company sells three of these
items at the end of the year.
Item
Purchase Price
#1
$5
#2
$7
#3
$8
#4
$9
#5
$11
2-15
Assets
Cost flow assumptions
Resulting effect on the income
statement and balance sheet
2-16
Assets
Current Assets – Prepaid Expenses
 Expenses paid in advance




Insurance
Rent
Property taxes
Utilities
 Included in current assets if they expire within
one year or one operating cycle
 Generally not material to the balance sheet
2-17
Assets
Property, Plant, and Equipment
 Encompasses a company’s fixed assets
 Not used up during annual operations
 Produce economic benefits for more than
one year
 Have physical substance
 Shown at book value on the balance sheet
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Assets
Property, Plant, and Equipment
 The relative proportion of fixed assets in a
company’s asset structure will largely be
determined by the nature of the business.
 Manufacturing firms typically have higher
percentages of fixed assets than retailers or
wholesalers.
 Firms with newly purchased assets will have
higher percentages of fixed assets than firms
with older fixed assets.
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Assets
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Assets
Example – Assume that Sage Inc. purchases an
artificial ski mountain for its Phoenix flagship store in
order to demonstrate skis and allow prospective
customers to test-run skis on a simulated course. The
cost of the mountain is $50,000 and is expected to
have a five-year useful life and $0 salvage value at the
end of that period.
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Assets
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Assets
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Liabilities
 Represent claims against assets
 Current liabilities
 Must be satisfied in one year or one operating cycle
 Noncurrent liabilities
 Obligations with maturities beyond one year
2-24
Liabilities
2-25
Liabilities
Current Liabilities – Accrued Liabilities
Example – Assume that a company has a
$100,000 note outstanding with 12% interest due
in semiannual installments on March 31 and
September 30. For a balance sheet prepared on
December 31, interest will be accrued for three
months (October, November, and December). The
December 31 balance sheet would include an
accrued liability of $3,000:
$100,000 x 0.12 = $12,000 annual interest
$12,000/12 = $1,000 monthly interest
$1,000 x 3 = $3,000 accrued interest for three
months
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Liabilities
Deferred Taxes
 Result of temporary differences in the recognition of
revenue and expense for taxable income relative to
reported income
 Depreciation methods are the most common source
for temporary differences.
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Liabilities
Example – Assume that a company has a total
annual revenue of $500,000, expenses other than
depreciation of $250,000, and a depreciation
expense of $100,000 for tax accounting and
$50,000 for financial reporting. The income for
tax reporting purposes would be computed two
ways, assuming a 34% tax rate:
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Liabilities
Taxes actually paid ($51,000) are less than
the tax expense ($68,000) reported in the
financial statements. To reconcile the
$17,000 difference between the expense
recorded and the cash outflow, there is a
deferred tax liability of $17,000:
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Stockholders’ Equity
 Also called shareholders’ equity
 Residual interest in assets that remains after
deducting liabilities
 Owners bear greatest risk and benefit from greatest
rewards.
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Stockholders’ Equity
Common Stock
 Shareholders
 do not ordinarily receive a fixed return
 have voting privileges in proportion to ownership
interest
 can benefit through price appreciation
 can suffer through price depreciation
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Stockholders’ Equity
Common Stock
• Dividends are declared at the discretion of a company’s board
of directors
• Amount listed on the balance sheet is based on the par or stated
value of the shares issued (which bears no relationship to actual
market price).
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Stockholders’ Equity
Retained Earnings
 Sum of every dollar a company has earned since inception
less any payments made to shareholders
 Funds a company has elected to reinvest in the operations
of the business rather than pay out in stock
 Measurement of all undistributed earnings
2-33
Stockholders’ Equity
Retained Earnings
 Key link between the income
statement and the balance sheet
 Unless there are unusual transactions
affecting the retained earnings
account,
Beginning
retained
earnings
±
Net
Ending
income – Dividends = retained
(loss)
earnings
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Stockholders’ Equity
Other Equity Accounts
 Preferred stock
 Accumulated other comprehensive income (expense)
 Treasury Stock
 Employee benefit trusts
 Equity attributable to non-controlling interests
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Stockholders’ Equity
2-36
Quality of Financial Reporting
 Economic recession of 2008 and many market
gyrations since can be traced directly to
overvaluation of balance sheet assets.
 When financial reporting does not reflect
economic reality quality and usefulness are
significantly impaired.
 Type of debt used to finance assets, commitments
and contingencies, and the classification of leases
relate directly to quality of financial reporting.
2-37
Quality of Financial Reporting
 “Commitments and Contingencies” disclosure in the
notes to financial statements provide important
information about off-balance sheet financing and
other complex financing arrangements.
 Enron is a prime example of a company with
enormous activity reported in the “Commitments
and Contingencies” disclosure.
2-38
Other Balance Sheet Items
 Corporate balance sheets are not limited to the
accounts described in this chapter.
 The reader of annual reports will encounter
additional accounts and will find many of the same
accounts listed under different titles.
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Create a Balance Sheet
 Using material from Paul’s Guitar Store, work
individually to create a balance sheet for year end
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