Assets under balance sheet
-current assets are expected to be sold or converted to cash within a year or one operational cycle
(operational cycle is the initial investment an entity makes in goods & services to when cash is received
from customers)
-Non-current assets are the opposite –not expected to be sold or converted to cash within a year/1
operational cycle. Ie: company equipment are expected to sit in a retail store as a economic resource to
provide the store a service for a number of years (staying within a year would constitute the asset as being
a non-current asset)
-if under assets in a balance sheet, there is no “current assets” then its assumed that all the assets listed are
non-current assets
GAAP rules state that in order for it to be an asset:
-asset must be the result of a transaction with another entity
-cost of an asset can be determined (GAAP requires that an asset be valued at the COST PAID for)
-asset must provide a future benefit to the entity AND the benefit must be REASONABLY
MEASURABLE
ie, we would generally classify advertisements as an asset from our intuition. However, according to
GAAP, its difficult to measure its future benefit as there is uncertainty and hard to measure
UNDER FINANCIAL STATEMENTS, GAPP REQUIRES ASSETS TO BE RECORDED AT COST,
NOT THE ASSET’S MARKET VALUE.
Liabilities under the balance sheet
-entity’s obligation to pay money or provide services to suppliers, lenders, and customers
We can have several types of liabilities:
A) A/P and accrued liabilities
B) Income tax payables
C) Current portion of long-term debt
D) Long-term debt
A/P and accrued liabilities are AMOUNTS OWED to suppliers for goods and services that x company
purchased on CREDIT
-the manufacturer has given x company time to pay its bills
Income tax payables are money owed to the government for income taxes
Current portion of long-term debt are MONEY BORROWED for more THAN ONE YEAR that is due to
be repaid within the next year
Long term debt are money borrowed that has to be REPAID in more than one year
Just like assets, liabilities can be classified into CURRENT and NON-CURRENT liabilities.
CURRENT liabilities- when obligations or debt will be paid within ONE year or operational cycle
NON-CURRENT liabilities- when obligations or debt will be paid in MORE than ONE year or
operational cycle
Rmb, if no liability is classified as a current liability it is assumed to be non-current liabilities.
*What’s the point in classifying assets and liabilities under current or non-current?
Its important to many users of financial statements because they want to assess an entity’s liquidity.
“Liquidity is an entity’s ability to pay its obligations as they come due; it refers to the availability of cash
or near-cash resources to meet obligations”
-important to CREDITORS as they would like to know if the company is able to pay back or to other
creditors who are looking to extend credit . As well SHAREHOLDERS may be interested to see if
company be in financial trouble due to the possibility of them going out of business.
Current assets = resources that are or will soon be available to meet obligations that are coming due
Current liabilities =obligations that must be fulfilled
Current assets and liabilities give important information about a company’s liquidity
Current assets – current liabilities = working capital
Working capital suggests that the company has the resources to meet its upcoming obligations which is
good.
Current assets/current liabilities = current ratio (a more attractive tool than working capital since it makes
comparisons a lot easier)
Current ratio gives the relative amounts of current assets to current liabilities
> ratio, the more current assets available to meet its current liabilities – more likely that the entity will
meet its obligations
Owner’s equity in a balance sheet
OE is the investment that the owners of an entity has made in the entity
Interchangeable terms in a financial statement:
Shareholder’s equity (referring to the OE of a CORPORATION)
Partner’s equity (Refering to the OE of a PARTNERSHIP)
Owner’s or proprietor’s equity (referring to the OE of a proprietorship)
Owners can make direct investments or indirect investments in entities
-direct investment is where the owner purchases SHARES of a corporation, UNITS of a partnership, or
contributes MONEY to a proprietorship
-indirect investment is when the NET INCOME of an entity is NOT distributed to the owners and is
therefore REINVESTED into the entity –considered an investment by owners since net income is not
distributed to owners
NET INCOME = REVENUE – all EXPENSES incurred to earn that revenue
In partnerships and proprietorships, direct and indirect investment may be combined together under the
financial statement
-partnerships can have separate lines for individual partner (each line showing their individual direct and
indirect investment or equity of the partners can be combined into a single line)
In corporations, the shareholder’s equity section in financial statements separates the direct and indirect
investments
-Capital stock (direct) represents the amount of money/assets that shareholders have contributed to the
corporation in exchange for shares in the corp
-Retained earnings (indirect) is the sum of all the net incomes a corporation has earned since it began
operations, less the dividends paid to shareholders ; called retained earnings b/c corp keeps the earnings
DIVIDENDS: payments of a cash (or assets in some cases) to its shareholders
-dividends are a representation of distribution of corporation’s net income to shareholders
Ex: if corporation reports capital stock of 3,130,000 in its Jan 21, 2010 balance sheet what does it mean?
It means that the 3,130,000 is the total amount of money that the shareholders have contributed.
??what does it mean when the company is buying back its shares from investors? ??
Ending Retained earnings = beginning retained earnings + Net income – Dividends
Repurchasing of capital stocks from investors is a reduce from Retained earnings
Debt to equity ratio: measure of how an entity is financed
DEBT TO RATIO= liabilities/shareholder’s equity (measures risk)
-HIGHER THE RATIO means MORE DEBT an entity has relative to equity
the MORE DEBT the organization has, the GREATER THE RISK  debt has a fixed cost (INTEREST)
ie. Organization borrowing $10,000 at a 10% interest rate.
Interest for 1 year would be (10,000 X 0.10 = 1000) $1000.
Amount borrowed is called PRINCIPAL amount.
-entity has an obligation to pay the loan back on time; lenders have rights
Lenders can sue the entity: Selling its assets, going to bankruptcy, renegotiating the terms of the loan
Whereas shareholders do not have any action if entity does not pay dividends out to them