The Balance Sheet
Accounting Is a Language
• Purpose: providing information
• Financial Statements
Financial Accounting:
The Balance Sheet
– Summarize accounting information
– Examples
Richard S. Barr
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• We need to know what the numbers in
the statements mean
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Accounting Information
BALANCE SHEET
• Kept for an entity
• Shows a financial picture of the entity
at one point in time
• A “snapshot”
– Corporation, partnership, government,
proprietorship
– Any organization or unit for which
financial statements are prepared
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Balance Sheet: Layout
Assets
• Heading
Resources owned by the entity
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– Cash, equipment, other resources are
needed to operate an entity
– People, the most important resource, are
not represented
– Total assets as of a particular date are
shown
• Assets shown on left -hand side
• Liabilities and equity shown on righthand side of sheet
• Where do assets come from?
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The Balance Sheet
Liabilities
Equity
• A source of assets
• Amounts provided by creditors of the
entity
• A second source of assets
• Two types of equity funds
– Accounts payable - credit from suppliers
– Bank loan payable - funds loaned by bank
– Paid-in capital
• Funds provided by equity investors for
stock
– Retained Earnings
• Creditors have first claim on assets
• Accumulated, undistributed earnings, or
profits
– Since assets are used to pay off claims
– Claims are against all assets, not specific
ones
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Residual Claims of Investors
Liabilities & Equity
• If the entity is dissolved,
• Viewed as both
– Creditors can sue the entity if amounts due
are unpaid
– Equity investors have a residual claim:
– Funds supplied by creditors and equity
investors to acquire assets
– Claims against assets
• Receive what remains after liabilities are paid
• So liabilities are a stronger claim
against assets
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1. The Dual-Aspect Concept
• Accounting Principle 1
– First of 9 fundamental accounting concepts
Balance Sheet Principles
• Rationale
– Assets not claimed by creditors will be
claimed by equity investors
– Total claims < what is available
– Hence total assets will always equal total
claims (liabilities + equity)
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The Balance Sheet
Assets = Liabilities + Equity
Applications of A=L+E
• “The Dual-Aspect Concept”
• Always holds in a balance sheet
• The residual interest of equity:
Equity = Assets - Liabilities
• Company A has $3,000 in liabilities
and $16,000 in equity.
– Any deviation is due to a record-keeping
error
• Hence the notion of a “balance sheet”
Total assets =
• Company B has $20,000 in assets and
$8,000 in liabilities
Equity =
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Balance Sheet Terminology
Balance Sheet As a Snapshot
Ordinary term
• Things of value
Accounting Term
•
• Since assets change daily
• One who lends
money to entity
• Creditors' claim
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• Investors' claims
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– So do liabilities and equity
• Balance sheet reports their levels at a
point in time
– Date must be shown
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2. Money-Measurement Concept
Money Measurement Concept
• Accounting Principle 2
• All amounts in accounting reports are in
monetary units
Means that accounting:
• Is an incomplete record of the status of
a business
• May omit important facts
– All reported facts must be converted to
dollars and cents
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• Can use amounts arithmetically
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A strike is imminent
The health of the president
A profitable contract is about to be signed
The number of cars in inventory is ...
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The Balance Sheet
3. The Entity Concept
The Entity Concept: Example
• Accounting Principle 3
• Accounts are kept for entities
• Not the persons associated with them
• Sue Smith owns the Green Co.
• Sue Smith withdraws $100 from the
company
• Is Green Company better off or worse
off than before?
• Is Sue Smith better off or worse off
than before?
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4. The Going-Concern Concept
The Going-Concern Concept
• Accounting Principle 4
• Accounting must assume either
• The more realistic assumption
– Special rules apply in the other case
• Hence assets’ market value (if sold) is
not shown in the balance sheet
– Entities are about to cease operations, or
– They normally will keep on going
• Accounting assumes the entity:
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5. The Cost Concept
Cost Concept vs. Market Value
• Accounting Principle 5
• When an entity buys an asset,
accounting records the amount of the
asset as its cost
• Market value
– The amount for which an asset can be
sold in the marketplace
– The market value of some assets change
over time
– Some assets deteriorate
– Inflation can affect asset value
• Accounting focuses on assets’ cost
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The Balance Sheet
The Cost Concept: Rationale 1
The Cost Concept: Rationale 2
• Market value is difficult to estimate
• Knowing market value is unnecessary
– Re-valuations for each balance sheet
would be difficult
– Market values are subjective, costs
objective
– The entity will not sell many assets
immediately
– Will keep for use in operations
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Balance Sheet Does Not Show
• What the individual assets are worth
• What the entity is worth
• What is accounting’s answer to this
criticism?
Balance Sheet Items
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Balance Sheet Items
• Assets
– Current and Noncurrent
Assets
• Liabilities
– Current and Noncurrent
= Things of value
• Equity
• Most items are summaries of more
detailed accounts
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The Balance Sheet
3 Requirements of an Asset
1. Controlled by the Entity
1. Controlled by the entity
2. Valuable to the entity
3. Measurable costs
• Requirement 1: The item must be
controlled (owned) by the entity
– Rental space?
– Employees?
– Contracts for valuable people?
• Certain special “capital leases” qualify,
and are discussed later
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2. Valuable to the Entity
3. Measurable Cost
• Requirement 2: Valuable to the entity
• Assets include:
• Requirement 3: The item must have
been acquired at a measurable cost
• Purchased trademarks versus selfdeveloped reputation
– Collectable amounts owed by customers
– Regular stock in inventory
– Equipment in working condition
– Philip Morris purchased “7-Up” name
– Coca-Cola developed the value of the
name “Coke” over many years
• Do not include:
– Un-sellable inventory
– Non-working, irreparable equipment
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Current Assets: Definition
Current Assets: Examples
• Cash and assets expected to become
cash or used up soon, usually within
one year
• Cash
– Money on-hand or in bank account that
can be withdrawn at any time
– Theoretically cash is reduced when entity's
check is cashed
– Reported separately on balance sheet
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The Balance Sheet
Current Assets: Examples
Current Assets: Examples
• Securities
• Accounts receivable
– Stocks and bonds
– US Treasury bonds are promises to pay
amounts to owners
– An amount owed to the business due to
normal extension of credit
– Example: customer's monthly bill from
electric company
• Marketable securities
• Notes receivable
– Expected to become cash within one year
– Based on a customer's promissory note to
pay what is owed
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Current Assets: Examples
Current Assets: Examples
• Inventory
• Prepaid items
– Goods being held for sale,
– Supplies, raw materials, work-in-process
that will eventually be sold
– Car on dealer's lot?
– Car purchased for company use?
– Prepaid fire insurance
– Listed as Current Asset even if over a year
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Non-current Assets
Tangible Assets
• Assets expected to be useful for more
than a year
1. Assets with physical substance
2. Property, plant, and equipment
– Usual name for tangible, noncurrent
assets
– To be used by the entity for over a year
• Tangible and Intangible Assets
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The Balance Sheet
Tangible Assets
Intangible Assets
3. Accumulated Depreciation
• Other noncurrent assets, without
physical substance
• Investments
– That portion of the tangible assets that
have been “used up”
– Subtracted from cost to yield a “net”
– Securities to be held over one year
– Otherwise, they would be listed as...
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Intangible Assets: Types
Intangible Assets
• Patents and trademarks
• Goodwill
– The rights to use patents and valuable
names
– Because they are assets we know that
they...
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– Can be created when one company buys
another company
– The amount paid for the company in
excess of the value of its assets
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Liabilities
Current Liabilities: Examples
• What is a liability?
• Accounts payable
– Amount owed a creditor
– Source of assets
– Claim on assets
– Amounts owed by the entity to its
suppliers
– The opposite of Accounts Receivable
– Example: 60-day credit
• What is a current liability?
• Bank loan payable
– Claims due soon, usually within a year
– Similar to Notes Receivable
– Debt is evidenced by promissory note
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The Balance Sheet
Current Liabilities: Examples
Current Ratio
• Accrued Liabilities
• Current assets and current liabilities
indicate
– Amounts owed to employees and others
for unpaid services rendered
– The entity's ability to meet its current
obligations
• Estimated tax liability
– Amount owed to the government in
taxes, within a year
• One measure: the current ratio
Current assets
Current liabilities
• Long-term debt (current portion)
– That portion of long -term debt due
within a year of the balance statement
• Should be at least 2:1
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Noncurrent Liabilities
• Long-term debt (noncurrent portion)
– Long-term, borrowed funds to be repaid
after one year
– Note: single liabilities may be divided into
current & noncurrent, but not single assets
EQUITY
• Deferred income taxes
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Equity Defined
Paid-in Capital
• Capital obtained from sources other
than accounts payable, debt, and
other liabilities
• Supplied by equity investors
– The owners of the entity
– If a corporation, the shareholders
– Paid-in capital
– Retained earnings
• Amount paid to entity for shares of
stock
– By the original stockholders!
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The Balance Sheet
Paid-in Capital
Retained Earnings
• Does not reflect the current value of the
shares of ownership
• Hence transactions between individuals
do not directly affect the entity
• Equity earned by profitable operation of
the entity
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• Cumulative profits since the entity
began
• Not cash. Why?
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In Summary
KEY POINTS
• The equity section of balance sheet
reports on capital from
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– Equity investors (paid -in capital)
– Undistributed profits (retained earnings)
• Equity section is also labeled
– Shareholders’ Equity
– Owners’ Equity
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Assets
Sources of assets
Claims on assets
Dual-aspect concept
Money measurement concept
Entity concept
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KEY POINTS
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Going-concern concept
Cost concept
Current assets and liabilities
Current ratio
Marketable security vs. investment
Equity
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