BALANCE SHEET
Accounting ASW
Summer 2007
Assets = Liabilities + Owners’ Equity
• Net Worth
• Explains the components of net worth
Reason for mis-valuation
• Accounting omits many assets
• Accounting mis-values many assets
• FASB/IASB know and do it intentionally
Asset Definition
• Probable net future cash inflow
• Currently right to it (often title)
• Past transaction provided right
• Future benefits reasonably quantifiable
Are these recognized as assets?
• Cash, accounts receivable and PP&E?
• Yes, recognized as assets
• Intangibles
- patents/R & D,
- trademarks/advertising
- goodwill?
• Recognized only if purchased externally
• Executory contracts
- situations in which contracts have been signed but neither party has acted
- e.g., purchase contracts, rental agreements, etc.
• Generally not
• Employees
• Never
Asset Valuation
• Most assets are value based on historical cost (e.g., inventory, PP&E, land)
- Initially at acquisition cost
- Inclusive of the cost of putting in place--e.g., labor, taxes, transportation, etc.
• PP&E is reduced by: - depreciation of normal use
- impairment if value falls below book
• Inventory reduced to lower of cost or market
• Accounts receivable are reduced for estimated bad debts
• A few assets are valued at fair market value
- e.g., some debt and equity securities and financial instruments
- increasingly common, especially with financial instruments
- remains controversial
Asset Classification (US)
• Current assets—one year (or operating cycle) until cash
• Noncurrent assets—longer term
– E.g., Strategic investments in other companies;
property, plant and equipment; intangible assets
• Problem 2.17
Problem 2.17: Is there an asset created if? Rents space for five years, starting next month. Pays $125K for 1st year rent & $130K deposit. Commits to paying $500K later for last 4 years.
Spends $10K on partitions, $6.5K on paint & 20K on carpet.
Buys display counter for $30K less 2% discount; pays $1.2K to transport and $0.8K to install.
Hires store manager at $60K.
Spends $1.5K on this month’s advertising.
Buys $160K of inventory; pays for $120K with 2% discount; $12K is returned, rest is still owed.
Liability Definition
• Probable net future cash (or service/goods outflow)
• Unavoidable obligation to pay it
• Created by past transaction or exchange
• Amount (and time) can be reasonably estimated
Are these recognized as liabilities?
• Accounts payable, long-term debt? • Yes, recognized as liabilities
• Contingencies and litigation? • Rarely; if probable and reasonably estimable
• Executory contracts? • No?
• Employees?
Liability Classification
• Current liabilities - due within a year (or operating cycle) - includes the current portion of long-
term debt • Noncurrent liabilities—longer term
- E.g., non-current long term debt; weird
liabilities like deferred taxes, pension
liabilities, etc.
Liability Valuation
• Expected cash outflow for most current liabilities
- e.g., accounts. payable, salaries payable, etc.
- not worth the effort of discounting• Discounted present value of future cash
outflow for long-term debt (including current portion)
- typically clear from amount received at issuance
• Problem 2.18
Problem 2.18: Is there a liability created if?
Sign contract to have landscaping done next year for $7.5K.
Receive $72 for magazine subscription starting next year.
Receive $2M toward a $10M bridge to be started next year.
Issue common stock for $7.6M.
Receive $100K bank loan, 6% interest to be paid.
Sign a contract to purchase at least $60K of supplies next year.
Place a $15K order on the above contract.
Owners’ Equity
• Residual (assets - liabilities)
Owners’ Equity Classification
• Contributed Capital • Par value (shares outstanding times
par value per share)--arbitrary • Capital in excess of par (proceeds
minus par value)
• Retained earnings (cumulative earnings net of dividends)
• Other--foreign currency translation etc.
Basic Journal Entries
• Debits: on the left
• Credits: on the right
• Assets increase with debits
• Liabilities increase with credits
• Debits=Credits implies Assets=Liabilities + Owners’ Equity
Buy inventory for cash
Buy inventory on credit
Issue stock for cash
Pay off accounts payable
Sell inventory at cost
Problem 2.27, 2.29
Problem 2.27: What journal entries for: 1. Issue stock for $30K.
2. Borrow $5K from bank, 6% future interest.
3. Rent a building and prepay $12K.
4. Acquire equipment for cash of $8K.
5. Acquire $25K of inventory, $12K for cash,
the rest on credit.
6. Sign a contract to provide $2K of groceries per week, receive $4K advance.
7. Buy insurance starting next year for $1.2K cash.
8. Pay $600 in advance for ads for next month.
9. Place a supplies order for $35K to be delivered
and paid for next month.
Problem 2.29: Prepare balance sheet, new co. 1. Issue stock for $800K.
2. Acquire land for $50K, building for $450K.
3. Purchase inventory on account for $280K.
4. Pay for $250K in 3, with 2% discount.
5. Pay $12K for one year insurance, starting next year.
6. Borrow $300K from bank on 12/31.
7. Acquire equipment on 12/31 for $80K 6% note.
Contra Accounts
• Accumulate reductions in accounts
• Often used to separate historical cost frombook value
• Accumulated Depreciation - Contra-asset offsetting PP&E at cost - Credit balance
• Allowed for Doubtful Accounts - Contra to accounts receivable