Part of a set of financial statements:
From PLI’s Course Handbook
Basics of Accounting & Finance: What Every Practicing Lawyer Needs to Know – Summer 2006
#8650
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what is a balance sheet?
Karen Kincaid Balmer, CPA, CrFA
Kincaid Consulting LLC
Submitted by:
Albert Lilienfeld
Deloitte Financial Advisory Services LLP
What is a Balance Sheet?
Karen Kincaid Balmer
Presented by Albert Lilienfeld
Balance Sheet
There are five parts of a set of financial statements. The first three are the most recognized parts; i.e.
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Shareholders’ Equity
Notes
Why are there various parts to a set of financial statements?
Each part of the set of financial statements provide different, but necessary information.
The Balance Sheet is a snapshot of an Entity’s Financial Condition at a Single Point in time. It is best illustrated by the following equation.
Balance Sheet Equation:
Assets = Liabilities + Stockholders’ Equity
Why does this equation work? Think of it in terms of your home. The cost basis of your house is the Asset, your mortgage is the Liability, and the difference between the two is your Equity.
Another way of thinking about this equation is to think again of the house as the Asset, the mortgage as the Liability, and the remainder as a liability to you for the portion of the house that is not owed to the bank; i.e. Stockholders’ Equity is a business’ liability to the shareholder.
GAAP and the Balance Sheet
Generally Accepted Accounting Principles (GAAP) determine how and when each component is recorded and valued. Various components are valued differently in accordance with current U.S. GAAP.
Examples of Valuation Methods and Assets
Historic Buildings and Equipment
Fair Market Marketable Securities
First In First Out Inventory
Last In First Out Inventory
Weighted Average Inventory
Other Various
Understanding
Understanding the rules and valuation methods is the key to effectively using financial information. For example: If you were going to sell a business, you would not want to sell buildings and equipment at their historic cost basis if material capital appreciation had occurred over the holding period of the assets.
Financial information can vary significantly between companies in like businesses. For example: If one chemical company built its plant in 1930 and another built its plant during 1980, both would have recorded the cost in 1930 and 1980 dollars, respectively. Land purchased during various times would have the same issues of comparability in companies financial statements.
Basic Balance Sheet
Current Assets
Non-Current Assets
=
Current Liabilities
Long-Term Liabilities
Stockholders’ Equity
The Balance Sheet provides a picture of the economic resources of the entity, both tangible and intangible, both current and non-current.
Current Assets
Cash and Cash Equivalents
Marketable Securities
Accounts Receivable
Inventory
Prepaid Expense
Cash and Cash Equivalents
Cash
Short term, highly liquid investments that are both:
Readily convertible to cash
So near maturity that there is insignificant risk of change in value
Marketable Securities
Trading - gains (losses) to the Income Statement
Held-to-Maturity - gains (losses) to Stockholders’ Equity ‘Comprehensive Gains and Losses’
Available-for-Sale - gains (losses) to the Income Statement
Accounts Receivable
Amounts due from customers (clients) for the sale of goods or services
Due in less than one year generally
Net of amounts likely to be uncollectible
Reserve for uncollectible amounts disclosed on the balance sheet itself in parenthesis
Inventory Methods Effect on Reported Net Income
FIFO - Results in lower cost of goods sold (expense) during periods of rising prices, thus resulting in higher reported net income.
LIFO - Results in higher cost of goods sold during periods of rising prices, thus resulting in lower reported net income.
Inventory valuation methods are required to be discussed in the notes to the financial statements.
Lower of Cost or Market
Regardless of the inventory valuation method chosen … All inventory valuation methods must reflect the lower of cost or market on reported financial statements.
Prepaid Expenses
Expenses paid in advance, such as insurance and rent
Held as an asset until the asset has been ‘used’
Usually expensed equally over a period of time
Property, Plant and Equipment
Land
Buildings
Equipment
All valued at historic acquisition cost
All except land are subject to depreciation
Liabilities
Probable Future Sacrifices of Economic Benefits
Current v. Non-Current
Current - generally due in less than one year
Differentiation between short and long term used for various financial ratios
Current Liabilities
Accounts Payable
Accrued Expenses
Short-term Debt
Current Portion of Long-term Debt
Long-Term Liabilities
Long-Term Debt
Obligations Under Capital Leases
Pension and Post-Retirement Obligations
Commitments and Contingencies
Other
Pension and Post-Retirement Obligations
Recognition of future pension and post retirement obligations (such as retiree health care) for past employee services rendered.
Valuation rules are actuarially based and generally quite complex.
Essentially present value of future obligations
Commitments and Contingencies
Contingencies:
An existing condition or circumstance involving uncertainty as to possible gain or loss that will be resolved when some future event occurs or fails to occur.
Categories of Contingencies
Probable - likely to occur
Reasonably Possible - more than remote, but less than likely to occur
Remote - chance of occurring is slight
Record a Contingency
Only if:
The future event if probable
AND
The amount can be reasonably estimated
Disclose a Contingency
If it is reasonably possible that the event will occur, disclose:
The nature of the contingency
The estimated loss or range of possible loss
Or disclose that such an estimate cannot be made
Gain Contingencies
Generally are not recognized so as not to record revenue prior to its realization.
Stockholders’ Equity
Capital Stock
Additional Paid-In Capital
Retained Earnings
Accumulated Other Comprehensive Income
Accumulated Other Comprehensive Income
(Non-realized gains and losses)
Changes to marketable securities
Changes due to translation gains and losses
Other
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