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THE BALANCE SHEET

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BALANCE SHEET

Resources (Assets)

Resources (Assets)

Claims against resources (Liabilities)

Claims against resources (Liabilities)

Remaining claims accruing to owners

(Owner’s Equity)

Remaining claims accruing to owners

(Owner’s Equity)

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BALANCE SHEETFundamental Objectives

LiquidityLiquidity - length of time until assets are realized or converted to cash (or until a liability has to be paid)

SolvencySolvency – the ability of a firm to meet its debts as they come due

Financial flexibilityFinancial flexibility - ability of company to manage its cash flows (deal with emergencies or take advantage of unexpected opportunities)

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AssetsProbable future economic benefits

obtained or controlled by a particular entity

as a result of past transactions or events.

Basic Definitions - Basic Definitions - SFAC No. 6SFAC No. 6

Balance Sheet

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Basic Definitions - Basic Definitions - SFAC No. 6SFAC No. 6

LiabilitiesProbable future sacrifices of

economic benefits arising from present obligations of

a particular entity to transfer assets or provide

services to other entities as a result of past

transactions or events.

Balance Sheet

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Owners’ EquityThe residual interest in the assets of an entity that remains after its

liabilities are deducted.

Basic Definitions - Basic Definitions - SFAC No. 6SFAC No. 6

Balance Sheet

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Asset ClassificationsAsset Classifications

Current Assets

Current Assets

Cash Inventories

Receivables Prepayments

Balance Sheet Format

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Asset ClassificationsAsset Classifications

Noncurrent Assets

Noncurrent Assets

Investments and funds

Intangibles

Property, Plant, & Equipment

Deferred Charges

Balance Sheet Format

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Liability ClassificationsLiability Classifications

Current LiabilitiesCurrent

Liabilities

Accounts Payable

Short-term Notes Payable

Collections in advance of

unearned revenue

Accrued Expenses

Balance Sheet Format

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Liability ClassificationsLiability Classifications

Noncurrent Liabilities

Noncurrent Liabilities

Capital Leases

Long-term Notes Payable

Pension Liabilities

Bonds Payable

Balance Sheet Format

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Equity ClassificationsEquity Classifications

Owners’ Equity

Owners’ Equity

Capital Stock

Other Contributed Capital

Treasury Stock

Retained Earnings

Balance Sheet Format

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WORKING CAPITAL ANALYSIS

Current assetsLess: Current liabilitiesEquals: Working Capital

Current assetsCurrent liabilities

= Current Ratio (Working Capital Ratio)

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Additional Reporting Issues

Loss and gain contingencies Subsequent Events Disclosure Notes Valuations reported in the Balance Sheet Comparative Statements

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LOSS CONTINGENCIES

Disclose a lossloss contingency when . . .– Information available prior to issuance of

the financial statements indicates that it is probableprobable that an asset has been impaired or a liability has been incurred at the date of the statements, oror

– The amount of the loss can be reasonably estimated.reasonably estimated.

If both both conditions exist, loss contingency must be accrued (recorded)

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GAIN CONTINGENCIES

Gain contingencies are nevernever recorded prior to realization

““Conservatism”Conservatism”

They may be disclosed in footnotes discussed within the statements only if a high probability of realization exists

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ACCOUNTING FOR CONTINGENCIES

CONTINGENT LOSSES

Likelihood Accounting Action

Probable Recognize liability if amount can be estimated. If not disclose in a footnote

Reasonably possible

Disclose in a footnote

Remote No recognition required, may disclose in a footnote

   

CONTINGENT GAINS

Likelihood Accounting Action

Probable If amount can be estimated, conservative approach is to disclose in footnote.

Reasonably possible

May disclose in a footnote, but be careful to avoid misleading implications.

Remote No recognition or disclosure

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SUBSEQUENT EVENTS

Events occurring afterafter the Balance Sheet date but before the issuance of the financial statements

They would have a material effect on the financial statements12-31-x8

Subsequent PeriodSubsequent Period

3-8-x9

Balance SheetDate

Date FinancialsIssued

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SUBSEQUENT EVENTS Reported on the Balance Sheet (recorded)

– If they provide additional evidence about conditions that existedexisted at the balance sheet date

Reported in notes to the Balance Sheet– If they result from conditions that did not existdid not exist at

the balance sheet date, arose after that date, and do merit adjustment

Neither recorded or disclosed– Nonaccounting events or conditions that management

normally communicates through other means

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“RESERVES”

This term may be misinterpreted as a “fund of cash”

Confusing uses of “Reserves”– Contra asset:

• Reserve for uncollectible accounts• Reserve for depreciation

– Estimated liability (Reserve for warranties)– Appropriation of Retained Earnings (Reserve for future expansion)

Term, “reserve” should really be eliminated

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RETAINED EARNINGSRestrictions (Appropriations)

Limit the ability of the corporation to declare dividends– Required by law or contract– Voluntary decision by the Board of Directors

Entry is reversed when the reason for the restriction ceases to exist

The term “reserve” is permitted - but should be avoided since it is misleading!!!

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Limitations of Balance Sheet

Current value amounts may not be shown on the Balance Sheet.

Contains many estimates.

Certain assets and liabilities are not shown on the Balance Sheet, e.g., human resources.

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Ratio Analysis Liquidity (Solvency) Ratios

– Current Ratio– Acid-test Ratio

Efficiency Ratios– Inventory Turnover

Equity Position and Coverage Ratios– Debt-to-Equity

Profitability Ratios– Earnings Per Share