BALANCE SHEET

After studying this chapter you should be

able to understand
• Basic elements of the Balance Sheet
• Assets, Liabilities and Stockholders’ Equity
• Depreciation
• Depreciation Methods
 Basic elements of the Balance Sheet
• A balance sheet shows the financial condition of
an accounting entity as of a particular date. The
balance sheet consists of assets, the resources of
the firm; liabilities, the debts of the firm; and
stockholders’ equity, the owners’ interest in the
firm. The assets are derived from two sources,
creditors and owners. At any point in time, the
assets must equal the contribution of the
creditors and owners. The accounting equation
expresses this relationship:
Assets = Liabilities + Stockholders’ Equity
 Assets
• Assets are probable future economic benefits
obtained or controlled by an entity as a result of
past transactions or events. Assets may be
physical, such as land, buildings, inventory of
supplies, material, or finished products. Assets
may also be intangible, such as patents and
trademarks.
 Current Assets
• Current assets are listed on the balance sheet in
order of liquidity (the ability to be converted
to cash). Current assets typically include
• Cash
• Marketable Securities
• Short-term Receivables
• Inventories
• Prepaids
 Cash

• the most liquid asset, includes negotiable

checks and unrestricted balances in
checking accounts, as well as cash on
hand. Savings accounts are classified as
cash even though the bank may not
release the money for a specific period of
time.
 Marketable Securities
• Marketable securities (also labelled short-term
investments) are characterized by their
marketability at a readily determinable market
price. A firm holds marketable securities to
earn a return on near-cash resources.
Management must intend to convert these
assets to cash during the current period for
them to be classified as marketable securities.
 Accounts Receivable Accounts
• Receivable are monies due on accounts that
arise from sales or services rendered to
customers. Accounts receivable are shown net
of allowances to reflect their realizable value.
This amount is expected to be collected. The
most typical allowances are for bad debts
(uncollectible accounts).
 Inventories

• Inventories are the balance of goods on

hand. In a manufacturing firm, they
include raw materials, work in process,
and finished goods.
 Prepaid
• A prepaid is an expenditure made in advance
of the use of the service or goods. It represents
future benefits that have resulted from past
transactions. For example, if insurance is paid
in advance for three years, at the end of the
first year, two years’ worth of the outlay will
be prepaid. Typical prepaid includes:
advertising, taxes, insurance
 Long-Term Assets

• Long-term assets are usually divided into

four categories:
1. Tangible Assets
2. Intangible Assets
 Tangible Assets
• These are the physical facilities used in the
operations of the business. The tangible assets
of land, buildings, machinery, and construction
in progress will now be reviewed.
Accumulated depreciation related to buildings
and machinery will also be reviewed.
 Intangibles

• Intangibles are nonphysical assets, such as

patents and copyrights. Intangibles are
recorded at historical cost and amortized over
their useful lives or their legal lives, whichever
is shorter..
• Goodwill: Goodwill arises from the acquisition
of a business for a sum greater than the physical
asset value, usually because the business has
unusual earning power. It may result from good
customer relations, a well-respected owner, and
so on.
• Patents: patent, exclusive legal rights granted to
an inventor for a period of 20 years, are valued at
their acquisition cost.
• Trademarks: Trademarks are distinctive names
or symbols. Rights are granted to the holder for
10 years and may be renewed every 10 years
thereafter.
 Copyrights
• Copyrights are rights that authors,
painters, musicians, and other artists have
in their creations and expressions. A
copyright is granted for the life of the
creator, plus 70 years.
 Liabilities
• Liabilities are 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. Liabilities are
usually classified as either current or
long-term liabilities.
 Stockholders’ Equity
• Stockholders’ equity is the residual ownership
interest in the assets of an entity that remains
after deducting its liabilities. Usually divided
into two basic categories, paid-in capital and
retained earnings, other accounts may appear in
stockholders’ equity that are usually presented
separately from paid-in capital and retained
earnings.
 Example of Paid-In Capital

• Company B issues 2,000 shares of common

stock with a par value of $2 per share. The
market price per share is $20 per share. Paid-
in capital is the total amount paid by investors
for common or preferred stock. Therefore, the
total paid-in capital is $40,000 ($4,000 par
value of the shares + $36,000 amount of
additional capital in excess of par).
 1. Common stock
• Common stock shares in all the stockholders’
rights and represents ownership that has voting
and liquidation rights. Common stockholders
elect the board of directors and vote on major
corporate decisions. In the event of
liquidation, the liquidation rights of common
stockholders give them claims to company
assets after all creditors’ and preferred
stockholders’ rights have been fulfilled.
 2. Preferred stock
• Preferred stock is a different type of equity that
represents ownership of a company and the
right to claim income from the company's
operations. Preferred stockholders have a higher
claim on distributions (e.g. dividends) than
common stockholders
 Treasury Stock
• The portion of shares that a company keeps in
their own treasury. Treasury stock may have
come from a repurchase or buyback from
shareholders; or it may have never been issued
to the public in the first place. These shares
don't pay dividends, have no voting rights, and
should not be included in shares outstanding
calculations.
 Retained Earnings
• Retained earnings are the undistributed
earnings of the corporation that is, the net
income for all past periods minus the
dividends (both cash and stock) that have
been declared.
 Depreciation

Introduction :
•A business or concern holds fixed assets for regular
use and not for re-sale. The capability of a fixed asset
to render service cannot be unlimited. Except land, all
other fixed assets have a limited useful life. The benefit
of a fixed asset is received throughout its useful life.
 Depreciation Concept

The latin word ‘depretium’ literally means ‘reduction
of value’. So depreciation means the reduction in
value of assets which has to be considered for
determining revenue.


Long-term fixed assets are used in the process of
earning revenue. Due to regular use such assets
gradually lose their service potentials. Such losses are
considered as expired costs
which have to be matched against the periodic
revenues.
 definition
R. S. Anthony and J. S. Reece observed that “the
cost of an asset that has a long but nevertheless
limited life is systematically reduced over
that life by the process called depreciation.”
International Accounting Standard (IAS)-4 provides
that “Depreciation is the allocation of the depreciable
amount of an asset over its estimated
useful life.”
 Causes of Depreciation
A.Internal
•(i)Wear and tear : Plant & Machinery. Furniture,
Motor Vehicles etc. suffer from loss of utility due
to vibration, chemical reaction, negligent
handling, rusting etc.
•(ii) Depletion (or exhaustion) : The utility or
resources of wasting assets (like mines etc.)
decreases with regular extractions.
 Causes of Depreciation

B. External or Economic causes

•Obsolescence : Innovation of better substitutes,
change in market demand, imposition of legal
restrictions may result into discarding an asset.
 Depreciation methods
1. Straight-Line Method

2. Declining-Balance Method

3. Sum-of-the-Years’-Digits Method

4. Unit-of-Production Method
Straight Line method
In this method, an equal
amount is written off every year
during the working life of the
asset to nil or its residual value
at the end of its useful life.

30
 1. Straight Line Depreciation
Book value decreases linearly with time

B
Dt = n- S Where: Dt = annual depreciation charge
t = year
B = first cost or unadjusted basis
S = salvage value
n = recovery period

BVt = B - tDt Where: BVt = book value after t

years
SL depreciation rate is constant for each year: d = dt = 1/n
 Example: SL Depreciation
An argon gas processor has a first cost of $20,000 with a
$5,000 salvage value after 5 years. Find (a) D3 and (b) BV3
for year three. (c) Plot book value vs. time.

Solution: (a ) D3 = (B – S)/n
= (20,000 – 5,000)/5 (c) Plot BV vs.
= $3,000 time
BVt
20,000

(b) BV3 = B – tDt 11,000

= 20,000 – 3(3,000) 5,000
= $11,000
0 3 5 Year, t
Depreciation
Depreciation

Straight-Line
Expense is same amount for each year.
Depreciable cost - cost of the asset less its residual
value. Illustration 9-8
 Depreciation
Depreciation
(Straight-Line Method)
Depreciable Annual Accum. Book
Year Cost x Rate = Expense Deprec. Value
2011 $ 12,000 20% $ 2,400 $ 2,400 $ 10,600
2012 12,000 20 2,400 4,800 8,200
2013 12,000 20 2,400 7,200 5,800
2014 12,000 20 2,400 9,600 3,400
2015 12,000 20 2,400 12,000 1,000

2011 Depreciation expense 2,400

Journal
Accumulated depreciation 2,400
Entry
Depreciation
Depreciation

2. Declining-Balance
Decreasing annual depreciation expense over the asset’s
useful life.
Declining-balance rate is double the straight-line rate.
Rate applied to book value.
 Depreciation
Depreciation
Illustration: (Declining-Balance Method)
Declining Annual
Beginning Balance Deprec. Accum. Book
Year Book value x Rate = Expense Deprec. Value

2011 13,000 40% $ 5,200 $ 5,200 $ 7,800

2012 7,800 40 3,120 8,320 4,680
2013 4,680 40 1,872 10,192 2,808
2014 2,808 40 1,123 11,315 1,685
2015 1,685 40 685* 12,000 1,000

2011 Depreciation expense 5,200

Journal
Accumulated depreciation 5,200
Entry

* Computation of $674 ($1,685 x 40%) is adjusted to $685.

 4. SUM-OF-THE-YEARS’-DIGITS METHOD OF
DEPRECIATION

 Another method of calculating depreciation is based on

a fraction derived from the years’ digist for the useful life
of a plant asset
 Using fractions based on the number of years of a plant
asset’s useful life is called the sum-of-the-years’-digits
method of depreciation
 Like the straight-line method, the estimated salvage
value is subtracted from the original cost to compute an
estimated total depreciation expense
 This results in a last year ending book value equal
to the palnt asset’s salvage value
 SUM-OF-THE-YEARS’-DIGITS METHOD OF
DEPRECIATION

 The fractions are determined as follows:

 The years’ digits are added (1+2+3+4+5 = 15
 Then, using the sum of the years’ digits, a fraction is
created for each year with the years’ digits in reverse
order
 The sum-of-the-years’-digits method results in a last year
ending book value equal to the plant asset’s salvage
value
1. Calculate the fraction. Years’ Digits Fraction
1 5/15
2 4/15
3 3/15
4 2/15
5 1/15
15
 SUM-OF-THE-YEARS-DIGITS
METHOD OF DEPRECIATION
Plant asset: Computer Original cost: $2,000.00
Depreciation method: Sum-of-the-years-digits Estimated salvage value: $175.00
Estimated useful life: 5 years

Beginning Book Total Ending

Year Value Fraction Depreciation Annual Depreciation Book Value
1 $2,000.00 5/15 $1,825.00 $608.33 $1,391.67
2 1,391.67 4/15 1 $1,825.00 2 486.67 905.00
3 905.00 3/15 $1,825.00 365.00 540.00
4 540.00 2/15 $1,825.00 243.33 296.67
5 296.67 1/15 $1,825.00 121.67 175.00
Total $1,825.00

1. Calculate the fraction. Years’ Digits Fraction 2. Calculate the annual depreciation for year 1.
1 5/15 Original Cost $2,000.00
2 4/15 Estimated Salvage Value – 175.00
3 3/15 Estimated Total Depreciation
4 2/15 $1,825.00
5 1/15 Year’s Fraction  5/15
15 Annual Depreciation $608.33
39
 4. Units-of-Activity Method
• The units-of-activity method provides the
same amount of depreciation expense for
each unit of activity of the asset. Depending
on the asset, the units of activity can be
expressed in terms of hours, miles driven, or
quantity produced.
• The units-of-activity method may also be
called the units-of-production method or
units-of-output method.
 Units-of-Activity Method
• The units-of-activity method is applied in the
following steps:
–
Depreciation
Depreciation

Units-of-Activity
Companies estimate total units of activity to calculate
depreciation cost per unit.
Expense varies based on units of activity.
Illustration 9-10
Depreciable cost is
cost less residual
value.
 PROBLEMS
• P-1 The following information was obtained from the accounts of Airlines International dated
December 31, 2017. It is presented in alphabetical order.
Accounts payable $ 77,916 Inventory 16,643
Accounts receivable 67,551 Investments and special funds 11,901
Accrued expenses 23,952 Long-term debt, less
current portion 393,808
Accumulated depreciation 220,541 Marketable securities 10,042
Allowance for doubtful accounts 248 Other assets 727
Capital in excess of par 72,913 Prepaid expenses 3,963
Cash 28,837 Property, plant, and equipment
at cost 809,980
Common stock (par $.50, authorized 20,000 Retained earnings 67,361
shares, issued 14,304 shares) 7,152
Current installments of Unearned transportation revenue (airline
long-term debt 36,875 tickets expiring within one year) 6,808
Deferred income tax liability
(long term) 42,070

Required: Prepare a classified balance sheet in report form

P-2 The following information was obtained from the accounts of Lukes, Inc. as of December 31, 2017. It is presented in scrambled order.
• Common stock, no par value, 10,000 shares authorized, $ 6000
• shares issued $ 3,180
• Retained earnings 129,950
• Deferred income tax liability (long term) 24,000
• Long-term debt 99,870
• Accounts payable 35,000
• Buildings 75,000
• Machinery and equipment 300,000
• Land 11,000
• Accumulated depreciation 200,000
• Cash 3,000
• Receivables, less allowance of $3,000 58,000
• Accrued income taxes 3,000
• Inventory 54,000
• Other accrued expenses 8,000
• Current portion of long-term debt 7,000
• Prepaid expenses 2,000
• Other assets (long term) 7,000
• Required Prepare a classified balance sheet in report form. For assets, use the classifications of current assets, plant and equipment,
and other assets. For liabilities, use the classifications of current liabilities and long-term liabilities.
P-3 The following information was obtained from the accounts of Alleg, Inc. as of December 31, 2017 It is presented
in scrambled order.
• Common stock, authorized 21,000 shares at $1 par value, issued 10,000 shares $
10,000
• Additional paid-in capital
38,000
• Cash 13,000
• Marketable securities 17,000
• Accounts receivable 26,000
• Accounts payable
15,000
• Current maturities of long-term debt 11,000
• Mortgages payable
80,000
• Bonds payable
70,000
• Inventory 30,000
• Land and buildings
57,000
• Machinery and equipment
125,000
• Goodwill 8,000
• Patents
10,000
• Other assets
50,000
• Deferred income taxes (long-term liability)
18,000