Introduction to Balance Sheet

We also have Quizzes, Crosswords, and Q&A for the topic Balance Sheet. The accounting balance sheet is one of the major financial statements used by accountants and business owners. (The other major financial statements are the income statement, statement of cash flows, andstatement of stockholders' equity) The balance sheet is also referred to as the statement of financial position. The balance sheet presents a company's financial position at the end of a specified date. Some describe the balance sheet as a snapshot of the company's financial position at a point (a moment or an instant) in time. !or e"ample, the amounts reported on a balance sheet dated #ecember $%, &'%% reflect that instant when all the transactions through December 31 have been recorded. (ecause the balance sheet informs the reader of a company's financial position as of one moment in time, it allows someone)li*e a creditor)to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. This is valuable information to the ban*er who wants to determine whether or not a company +ualifies for additional credit or loans. ,thers who would be interested in the balance sheet include current investors, potential investors, company management, suppliers, some customers, competitors, government agencies, and labor unions. -n art ! we will e"plain the components of the balance sheet and in art " we will present a sample balance sheet. -f you are interested in balance sheet analysis, that is included in the #$planation of %inancial &atios. We will begin our e"planation of the accounting balance sheet with its major components, elements, or major categories. Assets

'iabilities (wner's )Stockholders'* #quity

Assets
Assets are things that the company owns. They are the resources of the company that have been ac+uired through transactions, and have future economic value that can be measured and e"pressed in dollars. /ssets also include costs paid in advance that have not yet e$pired, such as prepaid advertising, prepaid insurance, prepaid legal fees, and prepaid rent. (!or a discussion of prepaid e"penses go to #$planation of Ad+ustin, #ntries.) 0"amples of asset accounts that are reported on a company's balance sheet include. Cash

etty Cash -emporary In.estments Accounts &ecei.able In.entory Supplies repaid Insurance 'and 'and Impro.ements Buildin,s #quipment /oodwill Bond Issue Costs 0tc.

1sually these asset accounts will have debit balances. Contra assets are asset accounts with credit balances. (/ credit balance in an asset account is contrary)or contra )to an asset account's usual debit balance.) 0"amples of contra asset accounts include. Allowance for 0oubtful Accounts

Accumulated 0epreciation1'and Impro.ements Accumulated 0epreciation1Buildin,s Accumulated 0epreciation1#quipment Accumulated 0epletion

0tc.

Classifications (f Assets (n -he Balance Sheet

/ccountants usually prepare classified balance sheets. 2lassified means that the balance sheet accounts are presented in distinct groupings, categories, or classifications. The asset classifications and their order of appearance on the balance sheet are. Current Assets

In.estments roperty2 lant2 and #quipment Intan,ible Assets (ther Assets

current assets
2ash and other resources that are e"pected to turn to cash or to be used up within one year of the balance sheet date. (-f a company's operating cycle is longer than one year, an item is a current asset if it will turn to cash or be used up within the operating cycle.) 2urrent assets are presented in the order of li+uidity, i.e., cash, temporary investments, accounts receivable, inventory, supplies, prepaid insurance.

in.estments
The long term asset category of a classified balance sheet which appears immediately after the current assets. 3isted in this category would be a bond sin*ing fund, funds held for construction, the cash surrender value of a life insurance policy owned by the company, and long term investments in stoc*s and bonds.

property2 plant2 and equipment

/ major classification on the balance sheet. -t is the second long term asset section after current assets. -ncluded are land, buildings, leasehold improvements, e+uipment, furniture, fi"tures, delivery truc*s, automobiles, etc. that are owned by the company. To learn more, see 0"planation of (alance Sheet.

intan,ible assets
Some e"amples of intangible assets include copyrights, patents, goodwill, trade names, trademar*s, mail lists, etc. These assets will be reported at cost (or lower) on the balance sheet after property, plant and e+uipment. Trade names and trademar*s that were developed by a company (as opposed to buying them from another company at a significant cost) may not appear on the balance sheet, even though they might be a company's most valuable asset.

other assets
3ong term assets that are not classified as investments, property, plant, e+uipment, or intangible assets. /n e"ample is bond issue costs that are amorti4ed to e"pense over the life of the bonds.

cash
/ current asset account which includes currency, coins, chec*ing accounts, and undeposited chec*s received from customers. The amounts must be unrestricted. (5estricted cash should be recorded in a different account.)

petty cash
/ current asset account that represents an amount of cash for ma*ing small disbursements for postage due, supplies, etc.

temporary in.estments
/ current asset account which contains the amount of investments that can and will be sold in the near future.

accounts recei.able
/ current asset resulting from selling goods or services on credit (on account). -nvoice terms such as (a) net $' days or (b) &6%', n6$' signify that a sale was made on account and was not a cash sale.

in.entory
/ current asset whose ending balance should report the cost of a merchandiser's products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, wor*7in7process, and finished goods. The cost of inventory should include all costs necessary to ac+uire the items and to get them ready for sale. When inventory items are ac+uired or produced at varying costs, the company will need to ma*e an assumption on how to flow the changing costs. See cost flow assumption. -f the cost to replace inventory is less than the actual cost of the inventory, it may be necessary to reduce the inventory amount. See lower of cost or mar*et. To learn more, see 0"planation of -nventory and 2ost of 8oods Sold.

in.entory
/ current asset whose ending balance should report the cost of a merchandiser's products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, wor*7in7process, and finished goods. The cost of inventory should include all costs necessary to ac+uire the items and to get them ready for sale. When inventory items are ac+uired or produced at varying costs, the company will need to ma*e an assumption on how to flow the changing costs. See cost flow assumption. -f the cost to replace inventory is less than the actual cost of the inventory, it may be necessary to reduce the inventory amount. See lower of cost or mar*et. To learn more, see 0"planation of -nventory and 2ost of 8oods Sold.

prepaid insurance
/ current asset which indicates the cost of the insurance contract (premiums) that have been paid in advance. -t represents the amount that has been paid but has not yet e"pired as of the balance sheet date. / related account is -nsurance 0"pense, which appears on the income statement. The amount in the -nsurance 0"pense account should report the amount of insurance e"pense e"piring during the period indicated in the heading of the income statement.

land
/ long7term asset account that reports the cost of real property e"clusive of the cost of any constructed assets on the property. 3and usually appears as the first item under the balance sheet heading of 9roperty, 9lant and 0+uipment. 8enerally, land is not depreciated

land impro.ements
/ long7term asset which indicates the cost of the constructed improvements to land, such as driveways, wal*ways, lighting, and par*ing lots. 3and -mprovements will be depreciated over their useful life by debiting the income statement account #epreciation 0"pense and by crediting the balance sheet account /ccumulated #epreciation. 3and -mprovements.

buildin,s
(uildings is a noncurrent or long7term asset account which shows the cost of a building (e"cluding the cost of the land). (uildings will be depreciated over their useful lives by debiting the income statement account #epreciation 0"pense and crediting the balance sheet account /ccumulated #epreciation.

equipment
0+uipment is a noncurrent or long7term asset account which reports the cost of the e+uipment. 0+uipment will be depreciated over its useful life by debiting the income statement account #epreciation 0"pense and crediting the balance sheet account/ccumulated #epreciation (a contra asset account).

,oodwill
8oodwill is a long7term asset categori4ed as an intangible asset. 8oodwill arises when a company ac+uires another entire business. The amount of goodwill is the cost to purchase the business minus the fair mar*et value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase. The amount in the 8oodwill account will be adjusted to a smaller amount if there is an impairment in the value of the ac+uired company as of a balance sheet date.

bond issue costs

(ond -ssue 2osts is a noncurrent (or long7term) asset reported on the balance sheet under the classification of other asset . (ond -ssue 2osts include the professional fees and registration fees associated with the issuance of bonds. The amount in the account (ond -ssue 2osts will be amorti4ed (systematically written off) to e"pense on the income statement over the life of the bonds.

'iabilities

'iabilities are obligations of the company: they are amounts owed to creditors for a past transaction and they usually have the word payable in their account title. /long with owner's e+uity, liabilities can be thought of as a source of the company's assets. They can also be thought of as a claim against a company's assets. !or e"ample, a company's balance sheet reports assets of ;%'',''' and /ccounts 9ayable of ;<',''' and owner's e+uity of ;=','''. The source of the company's assets are creditors6suppliers for ;<',''' and the owners for ;=','''. The creditors6suppliers have a claim against the company's assets and the owner can claim what remains after the /ccounts 9ayable have been paid. 3iabilities also include amounts received in advance for future services. Since the amount received (recorded as the asset 2ash) has not yet been earned, the company defers the reporting of re.enues and instead reports a liability such as 1nearned 5evenues or 2ustomer #eposits. (!or a further discussion on deferred revenues6prepayments see the #$planation of Ad+ustin, #ntries.) 0"amples of liability accounts reported on a company's balance sheet include. 3otes ayable

Accounts ayable Salaries ayable 4a,es ayable Interest ayable (ther Accrued #$penses ayable Income -a$es ayable Customer 0eposits 4arranty 'iability 'awsuits ayable 5nearned &e.enues Bonds ayable 0tc.

These liability accounts will normally have credit balances.

Contra liabilities are liability accounts with debit balances. (/ debit balance in a liability account is contrary)or contra)to a liability account's usual credit balance.) 0"amples of contra liability accounts include. 0iscount on 3otes ayable

0iscount on Bonds ayable 0tc.

Classifications (f 'iabilities (n -he Balance Sheet

3iability and contra liability accounts are usually classified (put into distinct groupings, categories, or classifications) on the balance sheet. The liability classifications and their order of appearance on the balance sheet are. Current 'iabilities

'on, -erm 'iabilities 0tc.

To see how various liability accounts are placed within these classifications, click here to .iew the sample balance sheet in art 6.

Commitments
/ company's commitments (such as signing a contract to obtain future services or to purchase goods) may be legally binding, but they are not considered a liability on the balance sheet until some services or goods have been received. 2ommitments (if significant in amount) should be disclosed in the notes to the balance sheet.

%orm .s7 Substance

The leasing of a certain asset may)on the surface)appear to be a rental of the asset, but in substance it may involve a binding agreement to purchase the asset and to finance it through monthly payments. /ccountants must loo* past the form and focus on the substance of the transaction. -f, in substance, a lease is an agreement to purchase an asset and to create a note payable, the accounting rules re+uire that the asset and the liability be reported in the accounts and on the balance sheet.

Contin,ent 'iabilities
Three e"amples of contingent liabilities include warranty of a company's products, the guarantee of another party's loan, and lawsuits filed against a company. 2ontingent liabilities are potential liabilities. (ecause they are dependent upon some future event occurring or not occurring, they may or may not become actual liabilities. To illustrate this, let's assume that a company is sued for ;%'',''' by a former employee who claims he was wrongfully terminated. #oes the company have a liability of ;%'','''> -t depends. -f the company was justified in the termination of the employee and has documentation and witnesses to support its action, this might be considered a frivolous lawsuit and there may be no liability. ,n the other hand, if the company wasnot justified in the termination and it is clear that the company acted improperly, the company will li*ely have an income statement loss and a balance sheet liability. The accounting rules for these contingencies are as follows. -f the contingent loss is probable and theamount of the loss can be estimated, the company needs to record a liability on its balance sheet and a loss on its income statement. -f the contingent loss is remote, no liability or loss is recorded and there is no need to include this in the notes to the financial statements. -f the contingent loss lies somewhere in between, it should be disclosed in the notes to the financial statements.

Current .s7 'on,1term 'iabilities

-f a company has a loan payable that re+uires it to ma*e monthly payments for several years, only the principal due in the next twelve months should be reported on the balance sheet as a current liability. The remaining principal amount should be reported as a lon,1term liability. The interest on the loan that pertains to the future is not recorded on the balance sheet: only unpaid interest up to the date of the balance sheet is reported as a liability.

3otes to the %inancial Statements

/s the above discussion indicates, the notes to the financial statements can reveal important information that should not be overloo*ed when reading a company's balance sheet.

(wner's )Stockholders'* #quity

(wner's #quity)along with liabilities)can be thought of as a source of the company's assets. ,wner's e+uity is sometimes referred to as the book .alue of the company, because owner's e+uity is e+ual to the reported asset amounts minus the reported liability amounts. ,wner's e+uity may also be referred to as the residual of assets minus liabilities. These references ma*e sense if you thin* of the basic accounting e+uation.

Assets 8 'iabilities 9 (wner's #quity and just rearrange the terms. (wner's #quity 8 Assets : 'iabilities

,wner's 0+uity are the words used on the balance sheet when the company is a sole proprietorship. -f the company is a corporation, the words Stoc*holders' 0+uity are used instead of ,wner's 0+uity. /n e"ample of an owner's e+uity account is ;ary Smith2 Capital (where ?ary Smith is the owner of the sole proprietorship). 0"amples of stoc*holders' e+uity accounts include. Common Stock

referred Stock aid1in Capital in #$cess of ar <alue aid1in Capital from -reasury Stock &etained #arnin,s 0tc.

(oth owner's e+uity and stoc*holders' e+uity accounts will normally have credit balances. Contra owner's equity accounts are a category of owner e+uity accounts with debit balances. (/ debit balance in an owner's e+uity account is contrary)or contra)to an owner's e+uity account's usual credit balance.) /n e"ample of a contra owner's e+uity account is ;ary Smith2 0rawin, (where ?ary Smith is the owner of the sole proprietorship). /n e"ample of a contra stoc*holders' e+uity account is -reasury Stock.

Classifications of (wner's #quity (n -he Balance Sheet

,wner's e+uity is generally represented on the balance sheet with two or three accounts (e.g., ?ary Smith, 2apital: ?ary Smith, #rawing: and perhaps Current =ear's 3et Income). See the sample balance sheet in art 6. The stoc*holders' e+uity section of a corporation's balance sheet is. aid1in Capital

&etained #arnin,s -reasury Stock

The stoc*holders' e+uity section of a corporation's balance sheet is.

S-(C>?('0#&S' #Q5I-= 9aid7in capital 9referred stoc* 2ommon stoc* 9aid7in capital in e"cess of par value 7 preferred stoc* 9aid7in capital in e"cess of par value 7 common stoc* 9aid7in capital from treasury stoc* 5etained earnings 3ess. treasury stoc* Total stoc*holders' e+uity

(wner's #quity .s7 Company's ;arket <alue

Since the asset amounts report the cost of the assets at the time of the transaction)or less)they do not reflect current fair mar*et values. (!or e"ample, computers which had a cost of ;%'',''' two years ago may now have a book .alue of ;=','''. @owever, the current value of the computers might be just ;$A,'''. /n office building purchased by the company %A years ago at a cost of ;<'',''' may now have a boo* value of ;&'','''. @owever, the current value of the building might be ;B'','''.) Since the assets are not reported on the balance sheet at their

current fair mar*et value, owner's e+uity appearing on the balance sheet is notan indication of the fair mar*et value of the company.

(wner's #quity and -emporary Accounts

5evenues, gains, e"penses, and losses are income statement accounts. 5evenues and gains cause owner's e+uity to increase. 0"penses and losses cause owner's e+uity to decrease. -f a company performs a service and increases its assets, owner's e+uity will increase when the Ser.ice &e.enues account is closed to owner's e+uity at the end of the accounting year.

#$ample Company Balance Sheet 0ecember @!2 "A!!

ASS#-S 2urrent assets 2ash 9etty cash Temporary investments /ccounts receivable 7 net -nventory Supplies 9repaid insurance Total current assets -nvestments 9roperty, plant E e+uipment 3and 3and improvements (uildings 0+uipment 3ess. accum depreciation 9rop, plant E e+uip 7 net -ntangible assets 8oodwill Trade names Total intangible assets ,ther assets Total assets

; &,%'' %'' %',''' <',A'' $%,''' $,D'' %,A'' DB,''' $=,'''

'IABI'I-I#S 2urrent liabilities Cotes payable /ccounts payable Wages payable -nterest payable Ta"es payable Warranty liability 1nearned revenues Total current liabilities 3ong7term liabilities Cotes payable (onds payable Total long7term liabilities

; A,''' $A,B'' D,A'' &,B'' =,%'' %,%'' %,A'' =%,''' 7 &',''' <'',''' <&','''

A,A'' =,A'' %D',''' &'%,''' Total liabilities (A=,''') $$F,'''

<D%,'''

7 %'A,''' &'',''' $'A,''' $,''' ;FF',''' Total liab. E stoc*holders' e+uity 7 ;FF',''' S-(C>?('0#&S' #Q5I-= 2ommon stoc* 5etained earnings 3ess. treasury stoc* Total stoc*holders' e+uity %%',''' &&B,''' (A',''') &DB,'''

The notes to the sample balance sheet have been omitted.