Chapter

Balance Sheet

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Balance Sheet
• Also called as statement of financial position and
statement of financial condition
• Shows financial condition as of a specific date
• The accounting equation expresses the
relationship among elements of balance sheet
Assets = Liabilities + Stockholders’ Equity
• Format
– Account form (side by side)
– Report form (assets at top and liabilities and
stockholders’ equity at bottom) dominant in the U.S.
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Exhibit 3-1—Quaker Chemical
Corporation

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Exhibit 3-1—Quaker Chemical
Corporation

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Assets
• Probable future economic benefits obtained or
controlled by an entity as a result of past
transactions or events
• May be physical or intangible
• Major categories
– Current Assets
• Includes cash, and assets that will be realized in cash during
the operating cycle or one year which ever is longer
– Noncurrent or Long-term Assets
• Includes assets that take longer than one year or operating
cycle to convert or to conserve cash

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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
• Cash
– Includes negotiable checks, unrestricted balance in
checking accounts, cash on hand, savings accounts

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Current Assets—Continued
• Marketable Securities—readily determinable
market price
– Debt or equity securities
– Carried at fair value
– To be converted into cash during the current period
• Accounts Receivable
– Amounts due from sales or services rendered
– Carried at net realizable value (net of allowances)
– All allowances are carried in one allowance account
– Other receivables due from nontrade sources

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Current Assets—Continued
• Inventories
– Balance of goods on hand
– Categories
• Merchandise on hand—retail or wholesale firms
• Raw materials
• Work in process Manufacturer
• Finished goods
– Carried at the lower of cost or market
– Supplies could include register tapes, pencils, or
sewing machine needles for the shirt factory

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Current Assets—Continued
• Prepaids
– Expenditures made in advance of the use of the
service or goods
– Represent future benefits resulting from past
transactions
– Examples
• Insurance
• Advertising
• Taxes
• Promotion costs
• Early payments on long-term contracts

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Long-Term Assets: Tangible
• Land
– Carried at acquisition cost
– Not subject to depreciation
– Natural resources are depleted
• Buildings
– Presented at cost plus permanent improvements
– Depreciated over their estimated useful life

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Long-Term Assets: Tangible—
Continued
• Machinery
– Historical cost, including costs of delivery, installation,
and material improvements
– Depreciated over its useful life
• Construction in Progress
– Assets under construction
– Costs will be transferred to permanent asset account
upon completion

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Long-Term Assets: Tangible—
Continued
• Accumulated Depreciation
– Carries the to-date depreciation of plant assets
– It is subtracted from the cost of the asset to determine
the book value
– Factors used in depreciation calculation
• Asset cost
• Length of the life of the asset
• Estimated salvage (residual) value of asset when retired

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Long-Term Assets: Tangible—
Continued
• Depreciation Methods
– Straight-line
– Declining-balance
– Sum-of-the-years’-digits
– Units-of-production
• Balance Sheet Presentation
Cost of the asset
Less: Accumulated depreciation
Net book value

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Depreciation: Straight-Line Method
• Cost of asset $10,000
• Estimated salvage $ 2,000
• Estimated life 5 years

Cost  Salvage Value

= Annual Depreciation
Estimated Value

$10,000  $2,000
 $1,600
5 Years

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Depreciation: Straight-Line Method —
Continued
• The salvage value is not depreciated and it
equals book value at end of useful life
Accumulated
Depreciation for Depreciation at Book Amount
Year Year End of Year Cost at End of Year
1 $1,600 $1,600 $10,000 $8,400
2 1,600 3,200 10,000 6,800
3 1,600 4,800 10,000 5,200
4 1,600 6,400 10,000 3,600
5 1,600 8,000 10,000 2,000

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Long-Term Assets: Leases
• Capital Lease
– It is in-substance an ownership arrangement
– Classified as long term asset; shown net of
amortization

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Long-Term Assets: Investments
• Debt or Equity Securities
– Held to maintain business relationship or to exercise
control
• Debt Securities Classification
– Held-to-maturity securities are carried at amortized
cost
– Available-for-sale securities are carried at fair value

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Long-Term Assets: Investments—
Continued
• Equity Securities
– Carried at fair value which have 3 levels for input
• Level 1: Quoted price for identical item in active market
• Level 2: Adjusted quoted price of similar asset (or liability)
• Level 3: Present value of expected cash flows
– Exception- Equity method is used where there is
significant influence
• Cost is adjusted for the proportionate share of the rise/fall in
the retained profits of the subsidiary (investee)

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Long-Term Assets: Intangibles
• Intangibles are nonphysical assets
• They are recorded at historical cost
• An intangible asset that has a finite life is
amortized over its useful life
• An intangible asset with an indefinite life are
reviewed for impairment

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Long-Term Assets: Intangibles—
Continued
• Goodwill
– Arises form the acquisition of a business where price
paid exceeds the fair value of net assets
– According to U.S. GAAP it is not amortized but tested
annually for impairment
• Patents
– Exclusive legal rights granted to an inventor for a
period of 20 years
– Valued at their acquisition cost
– Amortized over shorter of legal or useful life

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Long-Term Assets: Intangibles—
Continued
• Trademarks
– Distinctive names or symbols
– Indefinite legal life
– Not amortized but tested for impairment annually
• Franchises
– Legal right to operate under a particular corporate
name, providing trade-name products or services
– Amortize over the life of the franchise

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Long-Term Assets: Intangibles—
Continued
• Copyrights
– Rights that authors, painters, musicians, sculptors,
and other artists have in their creations and
expressions
– It is granted for life of the creator, plus 70 years
– Amortize over the period of expected benefit

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Other Noncurrent Assets
• Few assets do not fit into any of the previously
discussed classification
– Include noncurrent receivables and noncurrent
prepaids

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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 future as a result of past
transactions or events
– Current Liabilities
– Long-term Liabilities

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Current Liabilities
• Obligations whose liquidation is reasonably
expected within one year or the operating cycle,
whichever is longer
• Require
– Use of existing current assets
– Creation of other current liabilities

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Current Liabilities—Continued
• 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

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Long-Term Liabilities
• Due in a period beyond one year or operating
cycle, whichever is longer
• Types
– Financing arrangements of assets
– Operational obligations

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Liabilities Relating to Financing
Agreements
• Notes Payable
– Promissory notes
– If secured by property, they are called mortgage notes
• Credit Agreements
– Ready lines of credit that may require a compensating
balance
– In return for giving a credit agreement, the bank or
insurance company obtains a fee
– Not a liability until funds are drawn

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Liabilities Relating to Financing
Agreements—Continued
• 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 the bond’s selling price

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Liabilities Relating to Operational
Obligations
• Deferred Taxes
– Caused by using different accounting methods for tax
and reporting purposes
– It causes tax expense for reporting purposes to be
higher than taxes payable according to the tax return
• The difference is deferred tax
• Warranty Obligations
– Estimated obligations arising out of product
warranties
– Estimated to recognize the obligation at the balance
sheet date and to charge expense
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Liabilities Relating to Operational
Obligations—Continued
• Noncontrolling Interest
– Previously called “minority interest”
– Reflects the ownership of noncontrolling shareholders
in the equity of consolidated subsidiaries less than
wholly owned
– Reported on consolidated financial statements as
equity, but separate from parents equity
– If material, analysis can be performed twice
• Once as a liability to be conservative and then as
shareholders’ equity item

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Liabilities Relating to Operational
Obligations—Continued
• Other Noncurrent Liabilities
• Redeemable Preferred Stock
– Excluded from stockholders’ equity
– For analysis, treated as a liability

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Stockholders’ Equity
• Also called shareholders’ equity
• The residual ownership interest in the assets of
an entity that remains after deducting its
liabilities
– Paid-in capital
– Retained earnings

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Stockholders’ Equity: Paid-In Capital
• Two basic types of capital stock
– Preferred
– Common
• Par value
– In some states, referred to as “stated value stock”
– Considered “legal capital” by many states
– Established by the articles of incorporation
– Usually a minimal value
• Some states allow the issuance of no-par stock

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Stockholders’ Equity:
Paid-in Capital—Continued
• Additional Paid-In Capital
– Issue price in excess of par (stated) value
– Other sources
• Treasury stock transactions
• Stock dividend transactions
• Donated capital

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Stockholders’ Equity: Common Stock

• Shareholder ownership
– Voting rights
• Election of board of directors
• Major corporate decisions
– Liquidation rights secondary to
• Creditors
• Preferred stockholders’

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Stockholders’ Equity: 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 excess of stated dividend rate
• Convertibility into common stock at holder’s discretion
• Callability by the corporation
• Redemption at future maturity date
• Preference in liquidation secondary to creditors

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Stockholders’ Equity: Donated Capital

• May be included in the paid-in capital

• Donated by outside entities
• Example: Shareholder surrender of stock

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Stockholders’ Equity: Retained Earnings

• Undistributed earnings of the corporation

– Net income for all prior periods
• Less dividends (both cash and stock) declared to
shareholders

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Stockholders’ Equity: Others
• Quasi-Reorganization
– Eliminates a deficit balance of retained earnings and
an equal amount from paid-in-capital
– Retained earnings dated as of the readjustment date
and disclosed in the financial statements for a period
of five to ten years
• Accumulated Other Comprehensive Income
– Represents retained earnings from other
comprehensive income
– Disclosed as a separate component on the face of the
balance sheet or in the notes
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Stockholders’ Equity: Others—
Continued
• Employee Stock Ownership Plans (ESOPs)
– A qualified stock-bonus plan, or a combination of
stock-bonus and money-purchase pension plan
– Tax benefits for the employer and employee
– Unearned compensation decreases stockholders’
equity

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Stockholders’ Equity: Others—
Continued
• Treasury Stock
– Stock purchased and held by the issuing corporation
– Record treasury stocks in two ways
– Par-value method
• Removes the paid-in capital in excess of par from the original
issue
• Appears as a reduction of paid-in capital
– Cost method
• Records treasury stock at the cost of the stock (presented as
a reduction of stockholders’ equity)
• Most firms record treasury stock at cost

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Statement of Stockholders’ Equity
• Reconciles the beginning and ending balances
of stockholders’ equity accounts
• Changes in stockholders’ equity accounts
– Issuance of stock increases paid-in capital
– Acquisition of treasury stock increases treasury stock
– Net income increases retained earnings
– Dividends decreases retained earnings
• This account is related to comprehensive
income

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Problems in Balance Sheet
Presentation
• Financial analysis is complicated by
– Many assets recorded at cost rather than fair
(replacement) value
– Varying valuation methods
• Within a firm from product to product
• Within an industry from firm to firm
– Not all items of value are listed as assets
– Certain contingent liabilities may be excluded

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International Consolidated Balance
Sheet (IFRS)
• Asset section
– Usually noncurrent assets are presented first,
followed by current assets
• Liabilities and Owner’s Equity section
– “Capital and reserves” are usually listed first, then
noncurrent liabilities, and at last, current liabilities
• The reserves sections of “capital and reserves” would not be
part of U.S. GAAP

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Subsequent Events
• Occur during the period between the balance
sheet date and the date statements are issued
• Types
– Events requiring retroactive recognition
• Relates to estimates that were made and subsequent events
indicates estimates were incorrect
– Events requiring disclosure in the notes to the
financial statements
• Does not affect the balance sheet, but is significant to the
users of the financial statement

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