The Balance Sheet Statement

Learning Objectives
1.How

balance sheet accounts are measured,

classified and presented.
2.How

balance sheet information is used.

3.Balance

sheet terminology and format

outside the U.S.
4.How footnotes aid to the understanding
of the firms accounting policies, contingent
liabilities, subsequent events, and relatedparty transactions
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The Accounting Equation

Assets = Liabilities + Equity
Shareholders Equity:
Whats left of the companys assets
after paying off liabilities.
It also referred to as net assets.

Balance sheet
classification:
Overview
ASSETS

Current assets
Property, plant and
equipment
Investments
Other assets

LIABILITIES

EQUITY

Current liabilities
Long-term debt
Other liabilities

Preferred and
common stock
Additional paid-in
capital
Retained earnings

Contributed
Capital

Elements of the balance

sheet
How the money is
invested

ASSETS

Where the money came from

=

LIABILITIES

EQUITY

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

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, shortterm investments (reported at the fair value),
receivables (estimated amount collectible),
inventory (LCM), prepaid expenses, etc.
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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 sinking
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).
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Balance Sheet Classification and

Measurement - Liabilities

Amount due
at maturity
Historical
cost

Discounted
present
value

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Liabilities

Legal obligations required future

payments of assets or services as a
result of a business entitys 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.

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Balance Sheet Classification and

Account Measurement
-Stockholders equity
Historical
par value
Historical
cost

Combination of
different
measurement
bases
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Stockholders Equity

Residual claims (assets-liabilities) to

the business entity from stockholders
including:
a. contributed capital
b. (+ or -)Accumulated Other
Comprehensive Income
c. retained earnings (or - deficit)
d. (-)treasury stock
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a. Contributed Capital

Par value of common stock

Par value of prefer stock

Paid-in capital in excess of par value

of common stock or preferred stock

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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

appropriated
unappropriated

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Balance sheet information

1. Rates of return

2. Capital structure Debt vs. Equity

ASSETS
LIABILITIES
+
EQUITY

Balance Sheet

ROA and ROCE

Helps
assess

3. Liquidity

Cash conversion

4. Solvency

Ability to pay debt

5. Flexibility

Operating and financial

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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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2. Capital Structure
The balance sheet provides critical
information for understanding an
entitys capital structure.
Capital structure refers to how much
of an entitys assets are financed from
debt versus equity sources.

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3. Liquidity Ratios

Liquidity measures how readily assets can

be converted to cash relative to how soon
liabilities will have to be paid in cash.
Current ratio: Indicate the level of current
resources available to pay current debts.
Current Ratio = Current Assets / Current
Liabilities

Question:
Does higher ratio always indicate better
financial status?
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4. Solvency

Solvency defines the ability of a company

to generate sufficient cash flows to
maintain its productive capacity and still
able to pay off the long-term debt.
Debt ratios provide information about the
amount of long-term debt in a companys
financial structure.
Long-term debt to assets =
Long term debt/Total assets
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Solvency (contd.)

A company that can not make timely

payments in the amount required
becomes insolvent and may be
compelled to reorganize or liquidate.

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5. Flexibility
Flexibility refers to the ability to adapt or
revise to a new strategy for different
circumstances.
The ability to adjust to unexpected
downturn in the economic environment
in which it operates or to take
advantage of profitable investment
opportunities when they arise.

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Which company is:

Deere
E-Trade
Potomac Electric Power
Wal-Mart

Analytical insights:
Understanding the business

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Balance sheet presentation:

International differences
U.S. Format:
Current Assets

+
Long-lived Assets

=
Current Liabilities

+
Non-current Liabilities

+
Stockholders Equity

U.K. Format:
Fixed Assets

+
Current Assets

Current Liabilities

Non-current Liabilities

=
Capital Employed

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Financial statement
Footnotes are an integral part of
footnotes

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

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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.
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Summary
1.

2.

3.

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).
Be alert for differences in balance
sheet measurement bases, account
titles, and statement format.
Financial statement footnotes provide
important information..
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