The Balance
Sheet and
Notes to the
Financial
Statements
2
Learning Objectives
 Describe the specific elements of the
balance sheet (assets, liabilities, and
owners’ equity) and prepare a balance
sheet with assets and liabilities properly
classified into current and noncurrent
categories.
 Identify the different formats used to
present balance sheet data.
3
Learning Objectives
 Analyze a company’s performance and
financial position through the
computation of financial ratios.
 Recognize the importance of the notes
to the financial statements, and outline
the types of disclosures made in the
notes.
 Understand the major limitations of the
balance sheet.
4
Usefulness of the Balance Sheet
• Reports the resources (assets), obligations
(liabilities), and residual ownership
claims (equity) of a company.
• Facilitates analysis of the company’s
ability to:
– meet short-term obligations (liquidity).
– pay all debts as due (solvency).
• Provides information about the company’s
financial flexibility.
5
Elements of the Balance Sheet
Assets
Probable future
economic benefit
obtained or
controlled by a
particular entity as
a result of past
transactions or
events
The inclusion of
“probable”
acknowledges
that accounting
is not an exact
science.
6
Elements of the Balance Sheet
Assets
Probable future
economic benefit
obtained or
controlled by a
particular entity as
a result of past
transactions or
events
The primary
purpose of the
balance sheet is
to help forecast
the future.
7
Elements of the Balance Sheet
Typical assets found on a
balance sheet are cash,
supplies, accounts
receivable, land, buildings,
and equipment.
8
Elements of the Balance Sheet
“Obligation”
includes legal,
moral, social,
and implied
commitments.
Liability
Probable future sacrifice
of economical benefit
arising from a present
obligation of a particular
entity to transfer assets or
provide services to other
entities in the future as a
result of past transactions
or events.
9
Elements of the Balance Sheet
Liability
An obligation to
provide services
is a liability.
Probable future sacrifice
of economical benefit
arising from a present
obligation of a particular
entity to transfer assets or
provide services to other
entities in the future as a
result of past transactions
or events.
10
Elements of the Balance Sheet
Typical liabilities include
accounts payable, notes
payable, and advances
from customers.
11
Elements of the Balance Sheet
Equity
Residual interest in the assets of an entity
that remains after deducting its liabilities.
Capital Stock
Paid-in Capital in Excess of Par
Retained Earnings
How to Classify Items on
the Balance Sheet
 Current (one
year or less)
 Noncurrent
(more than 1
year)
12
13
Current Assets
Cash and resources expected to be
converted to cash during the
entity’s normal operating cycle or
one year, whichever is longer,
are current assets.
•
•
•
•
Cash
Accounts and notes receivable
Inventories
Prepaid items
14
Operating Cycle
Cash
Collections
Purchases
Inventories
Receivables
Sale
s
15
Noncurrent Assets
• Investments
• Property,
plant, and
equipment
• Deferred
income taxes
16
Property, Plant, and Equipment
Property, plant, and
equipment are
properties of a
tangible and
relatively permanent
nature that are used in
the normal business
operations.
17
Intangible Assets
Intangible assets are
long-term rights and
privileges of a
nonphysical nature
acquired for use in
business operations.
18
Current Liabilities
Current liabilities are obligations
expected to be paid within one year
or the normal operating cycle.
• Accounts and notes payable
• Accrued expenses
• Current portion of long-term
obligations
• Unearned revenues
19
Current Liabilities
If the terms of the
agreement for a callable
obligation is due on
demand or will become
due on demand within
one year from the
balance sheet date, the
obligation should be
classified as current.
20
Noncurrent Liabilities
The current liability classification generally
does not include the following items:
 Debts to be liquidated from a noncurrent
sinking fund.

Short-term obligations to be refinanced.
21
Noncurrent Liabilities
• Long-term debt
• Long-term lease
obligations
• Deferred income
tax liability
• Pension
obligations
22
Noncurrent Liabilities
Long-term debt is reported
at its discounted present
value.
23
Contingent Liabilities
Past activities or
circumstances may
give rise to possible
future liabilities.
Potential obligations
that do not exist on
the balance sheet
date are known as
contingent liabilities.
24
Contingent Liabilities
An estimated liability is a
definite liability, so it is
not a contingent liability.
Owners’ Equity
Contributed Capital:
Capital stock usually is
 Capital stock the number of shares
issued multiplied by the
 Additional paid-in
par capital
or stated value.
25
Owners’ Equity
Contributed Capital:
The two types of capital
 Capital stock stock are preferred and
common.
 Additional paid-in capital
26
Owners’ Equity
Additional paid-in
Contributed Capital:
capital is the excess
 Capital stock invested above par or
stated value of the
 Additional paid-in capital
capital
stock.
27
Owners’ Equity
Retained earnings is the
amount of undistributed
earnings of past periods.
28
29
Evaluating Liquidity
 Current Ratio: current assets divided by
current liabilities.
 Quick Ratio: quick assets divided by
current liabilities (Acid-Test Ratio).
30
Liquidity Ratios Example
Cash
Net Accounts Receivable
Current Ratio
Inventory
Current Assets
Current Liabilities
Current
Assets
$200
Current$100
Liabilities
$ 30
70
100
$200
$100
= 2:1
31
Liquidity Ratios Example
Cash
Net Accounts Receivable
Inventory Quick Ratio
Current Assets
Current Liabilities
$100
Quick
Assets
Current$100
Liabilities
$ 30
70
100
$200
$100
= 1:1
32
Current Ratio
McDonald’s
0.5
Microsoft
2.8
Disney
1.2
Coca-Cola
0.7
Yahoo!
5.8
33
Overall Leverage
Debt Ratio: total liabilities divided by
total assets.
Total Assets
$400
Total Liabilities
300
Total $300
Liabilities
$400
Total
Assets
= 75%
34
Debt Ratio
McDonald’s
52.2%
Microsoft
25.6%
Disney
53.1%
Coca-Cola
56.1%
Yahoo!
13.8%
35
Asset Mix
The proportion of total assets in each
asset category.
Property, Plant, and Equipment
Total Assets
Asset$50
Group
$400
Total
Assets
$ 50
400
= 12.5%
36
Efficiency
“Asset Turnover” is a financial ratio
measuring how efficiently a company
uses its assets to generate sales.
Sales
$200
Total Assets
400
Sales
$200
Total
Assets
$400
= 0.50
37
Asset Turnover
McDonald’s
0.63
Microsoft
0.65
Disney
0.56
Coca-Cola
0.98
Yahoo!
0.33
38
Overall Profitability
Two ratios that measure overall
profitability are “Return on Assets” and
“Return on Equity.”
Return on Assets
Net Income
Total Assets
Stockholders’ Equity
Net $40
Income
$400
Total
Assets
$ 40
400
160
= 10.0%
39
Return on Assets
McDonald’s
Microsoft
Disney
Coca-Cola
Yahoo!
7.8%
20.2%
4.5%
18.5%
4.1%
40
Overall Profitability
Two ratios that measure overall
profitability are “Return on Assets” and
“Return on Equity.”
Return on Equity
Net Income
Total Assets
Stockholders’ Equity
Net $40
Income
$160 Equity
Stockholders’
$ 40
400
160
= 0.25%
41
Return on Equity
McDonald’s
16.4%
Microsoft
27.0%
Disney
Coca-Cola
Yahoo!
9.5%
42.0%
4.8%
42
Notes to Financial Statements
• Summary of significant accounting
policies.
• Additional information to support
summary totals.
• Information about items not included
in financial statements.
• Supplementary information required
by the FASB or the SEC to fulfill the
full-disclosure principle.
43
Subsequent Events
Balance
Sheet Date
Financial Statement
Period
Events in this period
may affect the reporting
of amounts in the
subsequent periods
Date Statements
Issued
Subsequent
Period
44
Subsequent Events
Balance
Sheet Date
Financial Statement
Period
Date Statements
Issued
Subsequent
Period
•Types of Events
•Those that materially affect one or more financial
statements.
•Those that create a need for a footnote.
45
Limitations of the Balance Sheet
 Does not disclose actual value of the
entity.
 Does not disclose effects of inflation.
 Classifications are not uniform among
companies.
 Does not disclose all assets and
liabilities.
46
The End