Chapter 3
Balance Sheet
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The Balance Sheet
• “Statement of Financial Position”
Stockholders'
Assets = Liabilities +
Equity
• Dated as of a specific date
• Format
– Account
– Report
Chapter 3, Slide #2
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Balance Sheet – Report Form
ABC Corporation
Balance Sheet
December 31, 20X6
ASSETS
Current assets
Plant and equipment
Goodwill
$ 281,157
142,258
55,254
Total assets
$ 478,669
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities
Long-term liabilities
Total liabilities
Stockholders' equity
Total liabilities and stockholders' equity
Chapter 3, Slide #3
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
$ 159,926
32,495
192,421
286,248
$ 478,669
Balance Sheet – Account Form
ABC Corporation
Balance Sheet
December 31, 20X6
Current assets
Plant and equipment
Goodwill
Total assets
$ 281,157
142,258
55,254
$ 478,669
Current liabilities
Long-term liabilities
$ 159,926
32,495
Total liabilities
Stockholders' equity
192,421
286,248
Total liabilities and
stockholders' equity
$ 478,669
Chapter 3, Slide #4
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Assets
• Probable future economic benefits obtained
or controlled by an entity as a result of past
transactions or events
– Current Assets
– Long-Term Assets
Chapter 3, Slide #5
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Assets
• Cash and assets that will be converted into
cash during the operating cycle or within a
year, whichever is longer
• Presented in order of liquidity
Chapter 3, Slide #6
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Assets (cont’d)
• Cash
– Negotiable checks, unrestricted balance in
checking accounts, savings accounts
• Marketable Securities
– Debt or equity securities
– Carried at fair value
– Intention to convert into cash during the current
period
Chapter 3, Slide #7
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Assets (cont’d)
• Accounts Receivable
– Amounts due from sales or services
– Carried at net realizable value (net of allowances)
• Other receivables due from nontrade sources
Chapter 3, Slide #8
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Assets (cont’d)
• Inventories
– Carried at lower of cost or market
– Categories
•
•
•
•
Goods on hand
Raw materials
Work in process
Finished goods
Manufacturer
Chapter 3, Slide #9
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Assets (cont’d)
• Prepaids
– Expenditures made in advance of the use of the
service or goods.
– Examples
• Insurance
• Advertising
Chapter 3, Slide #10
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Tangible
• Land
– Carried at acquisition cost
– Not subject to depreciation
– Natural resources are depleted
• Buildings
– Cost plus permanent improvements
– Depreciated over the useful life
Chapter 3, Slide #11
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Tangible (cont’d)
• Machinery
– Acquisition cost plus costs of delivery, installation,
and permanent improvements
– Depreciated over the useful life
• Construction in Progress
– Assets under construction
– Transferred to permanent asset account upon
completion
Chapter 3, Slide #12
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Tangible (cont’d)
• Accumulated Depreciation
– Carries the to-date depreciation of plant assets
– Factors used in depreciation calculation
• Asset cost
• Length of the life of the asset
• Estimated salvage (residual) value of asset when retired
– Depreciation methods
– Straight Line
– Sum-of-the-Years’-Digits
– Declining Balance
– Units of Production
• Balance sheet presentation
–
=
Cost of the asset
Accumulated depreciation
Net book value
Chapter 3, Slide #13
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Depreciation: Straight-Line Method
Cost............................. $10,000
Estimated life.............. 5 years
Estimated salvage.......... $2,000
Cost - Salvage Value
= Annual Depreciation
Estimated Life
10,000 - 2,000
= $1,600
5 years
Year
1
2
3
4
5
Deprec.
for the
Accumulated
Year
Depreciation Asset Cost
$1,600
$1,600
$10,000
1,600
3,200
10,000
1,600
4,800
10,000
1,600
6,400
10,000
1,600
8,000
10,000
Book
Value
$8,400
6,800
5,200
3,600
2,000
The salvage value is not
depreciated.
Chapter 3, Slide #14
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Depreciation: Declining-Balance Method
Cost............................. $10,000
Estimated life.............. 5 years
Estimated salvage.......... $2,000
1
 2 = double the straight-line rate
Estimated Life
Double the straight-line
rate is the maximum rate
1
 2  Book Value at Beginning of Year = Annual Depreciation
5
Year
1
2
3
4
5
Asset
Cost
$10,000
10,000
10,000
10,000
10,000
Beginning
Accum.
Dep.
$0
4,000
6,400
7,840
8,000
Beginning Deprec. for
Book Value
the Year
$10,000
$4,000
6,000
2,400
3,600
1,440
2,160
160
2,000
-
Ending
Book
Value
$6,000
3,600
2,160
2,000
2,000
Chapter 3, Slide #15
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Scrap value is not
used in the
depreciation formula
but depreciation
ends when the book
value is equal to the
salvage value.
Depreciation: Sum-of-the-Years’-Digits
Method
Cost............................. $10,000
Estimated life.............. 5 years
Estimated salvage.......... $2,000
Number of Remaining Years
  Cost - Salvage  = Annual Depreciation
Sum of Digits of Estimated Life
5
 10,000 - 2,000  = $2,666.67
1+2+3+4+5 
Cost
Minus
Year Salvage
1
$8,000
2
8,000
3
8,000
4
8,000
5
8,000
Fraction
5/15
4/15
3/15
2/15
1/15
Deprec. for
the Year
$2,666.67
2,133.33
1,600.00
1,066.67
533.33
Ending
Accum.
Dep.
$ 2,666.67
4,800.00
6,400.00
7,466.67
8,000.00
Ending
Book
Value
$ 7,333.33
5,200.00
3,600.00
2,533.33
2,000.00
Chapter 3, Slide #16
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Depreciation: Units-of-Production
Method
Cost............................. $10,000
Estimated salvage.......... $2,000
Estimated total hours..... 16,000
Cost - Salvage Value
= Per Unit Depreciation
Estimated Life in Capacity
10,000 - 2,000
= $0.50
16,000 hours
• Hours of Operation × Rate = Depreciation
• Asset is depreciated until salvage value is
reached
Chapter 3, Slide #17
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Leases
• Capital lease
– In-substance ownership
– Recorded as an asset net of amortization
Chapter 3, Slide #18
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Investments
• Debt or equity securities
– Held to maintain business relationship or to
exercise control
• Debt classification
– Held-to-maturity carried at amortized cost
– Available-for-sale carried at fair value
Chapter 3, Slide #19
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Investments (cont’d)
• Equity securities
– Carried at fair value
– Exception: with the ability to exercise significant
influence the equity method is used: cost is
adjusted for the proportionate share of the rise/fall
in the retained profits of the subsidiary (investee)
Chapter 3, Slide #20
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Intangibles
• Goodwill
– Purchase of a business where price paid exceeds
the fair value of net assets
– U.S. GAAP: not amortized; test annually for
impairment
• Patents
– 20 years
– Amortized over shorter of legal or useful life
• Trademarks
– Indefinite legal life
– Not amortized; test annually for impairment
Chapter 3, Slide #21
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Assets: Intangibles (cont’d)
• Franchises
– Life based on contract
– Amortize over shorter of legal or useful life
• Copyrights
– Life of the creator plus 70 years
– Amortize over shorter of legal or useful life
Chapter 3, Slide #22
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Liabilities
• Probable future sacrifices of economic
benefits arising from present obligations of a
particular entity to transfer assets or provide
services to other entities in the futures as a
result of past transactions or events
– Current Liabilities
– Long-Term Liabilities
Chapter 3, Slide #23
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Liabilities
• Obligations whose liquidation is reasonably
expected to
• Require the use of
– Existing current assets
– Creation of other current liabilities
• Within one year or the operating cycle,
whichever is longer
Chapter 3, Slide #24
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Current Liabilities (cont’d)
• Payables
– Short-term obligations created by the acquisition of
goods or services
• Unearned Income
– Payments collected in advance of the performance
of services or delivery of goods
• Other current liabilities
– As circumstances warrant
Chapter 3, Slide #25
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Liabilities
• Due in a period beyond one year or operating
cycle
• Related to
– Financing arrangements
– Operational obligations
Chapter 3, Slide #26
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Liabilities: Financing
Arrangements
• Notes Payable
– Secured by property: Mortgage notes
• Credit Agreements
– Ready lines of credit that may require a
compensating balance
– Not a liability until funds are drawn
Chapter 3, Slide #27
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Liabilities: Financing
Arrangements (cont’d)
• Bonds Payable
– Sold at par, premium, or discount
– Premium or discount is amortized into interest
expense
– Bond carrying value is amortized to par value
– Convertible bonds can be converted into common
stock
– Conversion feature enhances bond selling price
Chapter 3, Slide #28
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Bonds at Par, Premium, or Discount
Bond
Contractual
Interest Rate 8%
Market Interest
Rate
Bonds
Sold at
6%
Premium
8%
Par
(Face Value)
10%
Discount
Chapter 3, Slide #29
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Liabilities: Operational
Obligations
• Deferred Taxes
– Difference between accounting and tax methods
– Difference in the timing of recognizing revenue and
expense for accounting and tax purposes
• Warranty Obligations
– Estimated; arise from offering product warranties
– Estimated to achieve matching of sales revenue
and associated expense of warranty
Chapter 3, Slide #30
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Long-Term Liabilities: Operational
Obligations (cont’d)
• Minority Interest
– Reported on consolidated financial statements
– Represents the interest in the equity of a partiallyheld subsidiary by the nonmajority owners
– Not a liability per se but for purposes of analysis
treat as a liability
• Other Noncurrent Liabilities
– As circumstances warrant
• Redeemable Preferred Stock
– Excluded from stockholders’ equity
– For analysis, treat as a liability
Chapter 3, Slide #31
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity
• The residual ownership interest in the assets of
an entity that remains after deducting its
liabilities
– Paid-in Capital
– Retained Earnings
Chapter 3, Slide #32
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Paid-in Capital
• Par value
–
–
–
–
In some states, referred to as “stated value”
Considered “legal capital” by many states
Established by the articles of incorporation
Usually a minimal value
• No-par stock
Chapter 3, Slide #33
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Paid-in Capital
(cont’d)
• Additional paid-in capital
– Issue price in excess of par (stated) value
– Other sources
• Treasury stock transactions
• Stock dividend transactions
• Donated capital
Chapter 3, Slide #34
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Paid-in Capital
(cont’d)
• Common Stock
– Shareholder ownership
– Voting rights
• Election of board of directors
• Major corporate decisions
– Liquidation rights secondary to
• Creditors
• Preferred stock
Chapter 3, Slide #35
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Paid-in Capital
(cont’d)
• Preferred Stock
– Does not normally convey voting rights
– May carry any or all of these features:
•
•
•
•
•
•
•
Preference as to dividends
Accumulation of dividends
Participation in dividend beyond stated dividend rate
Convertibility into common stock at holder’s discretion
Preference in liquidation secondary to creditors
Callable at issuer discretion
Redemption at future maturity value
• Donated Capital
– Donated by outside entities
– Shareholder surrender of stock
Chapter 3, Slide #36
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Retained Earnings
• Undistributed earnings of the corporation
– Net income for all prior periods
– Less dividends declared to shareholders
Chapter 3, Slide #37
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Other
• Quasi-Reorganization
– Eliminates a deficit balance of retained earnings
– Retained earnings are dated for 5-10 years
• Equity-Oriented Deferred Compensation
– A reduction to stockholders’ equity that is amortized
(expensed) to future periods of employee service
Chapter 3, Slide #38
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Stockholders’ Equity: Other (cont’d)
• Employee Stock Ownership Plans (ESOPs)
– A qualified pension plan
– Tax benefits for the employer and employee
– Unearned compensation reduces stockholders’
equity
• Treasury Stock
– Stock purchased and held by the issuing
corporation
– Recording and disclosure
• Record at par value; deduct from paid-in capital
• Record at cost; deduct from total stockholders’ equity
Chapter 3, Slide #39
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Statement of Stockholders’ Equity
• Reconciles the beginning and ending balances
of all components of stockholders’ equity
• Account changes indicate
– Issuance of stock: paid-in capital increase
– Acquisition of treasury stock: treasury stock
increase
– Net income: retained earnings increase
– Dividends: retained earnings decrease
Chapter 3, Slide #40
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
Balance Sheet Presentation Issues
• Financial analysis is complicated by
– Many assets recorded at cost rather than fair
(replacement) value
– Varying valuation methods
• Within a firm from item to item
• Within an industry from company to company
– Not all items of value are listed as assets
– Certain contingent liabilities may be excluded
Chapter 3, Slide #41
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.