FINANCIAL STATEMENTS

UNDERSTANDING BALANCE SHEET

MAT-115
PROF. SALVADOR FIGUEROA NADAL
THE BALANCE SHEET
• The balance sheet discloses what an entity owns (or controls), what it
owes, and what the owners’ claims are at a specific point in time.

• The financial position os a company is described in terms of its basic

elements:
• Asset (A): are the company owns (or control).
• Liabilities (L): are what company owes.
• Equity (E): represents the owner’s residual interest in the company’s assets after
deducting its liabilities.
• Commoly know as Shareholder’s Equity o Owner’s Equity
THE BALANCE SHEET ALSO KNOWN AS

STATEMENT OF STATEMENT OF
FINANCIAL POSITION FINANCIAL CONDITION
THE BALANCE SHEET: DUELING VIEWS
• Record of capital invested: There are some who believe that the main function
of a balance sheet is to record how much a business has invested in its assets-in-
place, i.e., the assets that allow for its current operations to occur.

• Measure of current value: There is a large and perhaps dominant school of

thought among accountants, or at least accounting rule writers, that a balance
sheet should reflect the value of the business today.

• Liquidation value: There is a third school, with lenders to the firm among its
primary members, who feel that a balance should reflect what you would get for
the assets of the firm, if you liquidated them today.
REVISITING THE BALANCE SHEET
LET’S SEE SOME BALANCE

Apple vs
SAP
CURRENT VS NON-
CURRENT CLASSIFICATION
● Current assets: expected to be sold, used or
converted to cash <1 year
● Typically, current assets provide info about
operating activities or capabilities of the company,
while non- current assets represent infrastructure for
the company to operate, rather than consumed or
sold in current period, more strategic/long-term
perspective.

● Current liabilities: expected to be settled <1 year.

● Typically current liabs. are part of working capital used
in the operating cycle.

● Working Capital = Curr. Assets – Curr. Liabilities

CURRENT VS NON-CURRENT CLASSIFICATION
AND LIQUIDITY-BASED PRESENTATION
• US-GAAP and IFRS require current vs non-current classification. Order not
important.
• IFRS exception: liquidity-based presentation allowed if reliable and more
relevant (typical in banks and FIs)

Deutsche Bank
2020 Assets:
CURRENT AND FIXED OR NON CURRENT
ASSETS
• The Old Way: If you are old enough to learned your accounting two or
three decades ago, the way you were taught to value fixed and current
assets was to show them at original cost, net of accounting depreciation.

• The New Way: As accounting has increasingly adopted the fair value
standard, there has been a move to mark assets to current market value.

• Divergent Effects: The difference in values that you get for assets, using the
two approaches, varies. It is
• Greater on older assets than on newer ones
• Greater on fixed assets than current assets
CURRENT ASSETS

• Cash & Cash equivalents: includes short-

term investments close to maturity (< 3-mo), typically
reported at amortized cost or fair value (price to sell
the asset or transfer liability).
• Marketable Securities: investments in debt and
equity securities traded in a public market (e.g. T-bills,
bonds, equity securities). More info later on
measurement.
• Trade Receivables (aka accounts receivable):
usually amounts owed by customers for products or
services. Typically reported at net realizable value
(estimate of collectability). Contra account:
Allowance for doubtful accounts. (See bad debt tool)
CURRENT ASSETS (CONT.)
• Inventories: Physical products to be sold to
customers. Incl. finished goods, raw materials, and
work-in-process. Measured at:
•IFRS: lower of: cost and net realizable value
•US GAAP: lower of: cost or market value
• Cost includes all purchase, conversion, and bringing
inventories to current location and condition.
• Excludes abnormal amounts of wasted costs; storage
costs unless necessary prior to a production process;
adm. overhead; and selling costs.
• Net realizable value = selling price – est. costs of
completion and to make the sale.
• Market value = replacement cost, but ≤ NRV, and >
NRV – normal profit margin
CURRENT ASSETS (CONT.)
• Inventories:
• If NRV (IFRS) or market value (US GAAP)
falls below carrying amount, must write down
the value and reflect the loss. IFRS allows for a
reversal, US GAAP doesn’t.
• When sold, cost inventory reported as an
expense.

Apple (2020 Audited Statements)

CURRENT ASSETS (CONT.)

• Other Current Assets examples:

• Prepaid expenses
• Deferred tax assets
 Property, Plant & Equipment: tangible assets used
in company operations, expected to be used over
more than a fiscal period. Includes land, buildings,
equipment, cars, machinery, furniture, natural resources.
● IFRS: amortized cost for some classes of assets,
revaluation for others
NON-CURRENT
● US GAAP: at amortized cost
(LONG-TERM)
● Land is not depreciated.
ASSETS ● Choice of depreciation method and useful life
and salvage value impact both the BS and IS
● Impairments reflect unanticipated declines in
value. Occurs when asset’s recoverable amount
< carrying amount.
 Investment Property: Under IFRS, Property not
for production of goods and services or admin
purposes, but for rental income or capital appreciation.
● Cost model or fair value model for all
investment property.
NON-CURRENT
(LONG-TERM)
ASSETS
 • Intangible Assets: Non-monetary assets without
physical substance:
• Patents
• Licenses
• Trademarks
NON-CURRENT • Goodwill

(LONG-TERM) • US GAAP: Cost model

IFRS: Cost or Revaluation model (if there is an
ASSETS •
active market for the asset)
• Amortization if life is finite
• Impairment similar to PPE if finite
• Impairment for indefinite life, depends on
yearly review
 Identifiable Intangibles:
• Internally created, usually expensed rather than
capitalized, but:
• IFRS: research phase must be expensed,
development phase can be capitalized if
NON-CURRENT technologically feasible or ability to use or sell
the resulting asset.
(LONG-TERM) • US GAAP: No capitalization for most costs.
ASSETS • Mostly expensed: startup costs, training,
administrative and overhead costs, advertising
and promotion, relocation, redundancy and
other termination costs.
 Goodwill: price of purchase > acquirer’s interest in the
fair value of the target company’s assets and liabilities.
• This is capitalized under both US GAAP and IFRS.
• Not amortized, but reviewed annually for
impairment.
NON-CURRENT
(LONG-TERM)
ASSETS
 Financial Assets: Usually the liability (e.g. notes,
bonds, etc.) or equity (e.g. stocks) of another entity, or
derivatives.
• Fair value or amortized cost (See IFRS 9)
• Held-to-maturity (amortized cost)
NON-CURRENT • Available for sale (FVOCI fair value through
other comprehensive income)
(LONG-TERM) • Trading (FVPL – Fair Value through P&L)
ASSETS • Equity investments: <20% control. Trading if fair
value is readily available, while amortized cost
otherwise.
• If 20-50%, at amortized cost, adjusted for
company’s retained earnings
• 50%+ consolidated accounting.
 Financial Assets:
• Exhibit: Measurement of Financial Assets

NON-CURRENT
(LONG-TERM)
ASSETS
 Trade Payables (aka accounts payable): amounts
owed to vendors to purchase goods and services for
purchases on credit.

Notes Payable: financial liabilities (<1yr) from trade

creditors or banks through a formal loan agreement.

CURRENT Current portion of long-term debt

LIABILITIES
Taxes Payable: taxes not yet paid

Accrued Expenses: expenses recognized on the

income statement, but not yet paid and usually no
invoice yet

Deferred Income/Revenue: when receiving payment in

advance of delivery
 Financial Liabilities – Borrowings from Banks: reported at
amortized cost

NON-
CURRENT Financial Liabilities – Bonds and Notes Payable:
amortized cost or fair value:
(LONG-TERM)
LIABILITIES
EQUITY COMPONENTS
• Capital contributed by owners (common stock,
issued capital): Company must disclose the amount of
shares for each “class” of shares issued. See EGE Haina
example:

• Paid-in capital: value in excess of par value of shares

• Preferred shares: may be classified as equity or
financial liability based on characteristics (perpetual,
redeemable). Pref shares have rights over common
shareholders.
EQUITY COMPONENTS
• Treasury Shares: shares in the company that the
company itself repurchased, valued at price paid.
• Retained earnings: cumulative amount of earnings
recognized in the company’s income statement and
haven’t yet been paid to the owners of the company as
dividends.
• Accumulated other comprehensive income: may or
may not include net income from the income statement,
and includes other comprehensive income not
recognized as part of net income.
• Non-controlling interest: equity participation
(interest) of minority shareholders in subsidiaries that
have been consolidated by the company
MORE ON EQUITY
• Par Value: This is a throwback in time and should be
ignored.
• Company Age: Since shareholders’ equity reflects a
company’s cumulated history of equity raises and retained
earnings, young companies will tend to have far less
shareholders’ equity than older companies, of equivalent
market value..
• Capitalization effects: Since only capitalized expenses
become part of assets, shareholders’ equity can be skewed
by accounting rules and corporate actions on what is
capitalized and what is expensed.
MORE ON EQUITY
• Buyback effects: Both dividends and buybacks reduce
shareholders’ equity, by reducing it, but the magnitude of
buybacks makes their effect more dramatic.
• Negative equity: There is no mathematical reason why
shareholders’ equity cannot become negative, either
because a company has lost money for an extended
period or because of large buyback/write off.
 Time-series (trend) analysis

BALANCE
SHEET
ANALYSIS Common-size analysis

TOOLS

Financial Ratios
 Energy and utility companies tend to have
largest amount of PP&E as % of assets

Financial Institutions tend to have the largest %

of total liabilities (highly levered)
COMMON
EXPECTATIONS Telecoms and Utilities usually have low % of
receivables
BY SECTOR
Inventories are highest for consumer
discretionary, followed by Materials and
Consumer Staples sectors

Tech companies tend to have least amount of

leverage
BALANCE SHEET RATIOS

Ratios facilite time-series and cross-sectional

analysis of a company’s financial position.
• Balance sheet ratios are those involving
balance sheet itmes only
• Liquidity ratios: Measure the ability to meet
shot-terms obligations
• Solvency ratios: Measure the ability to meet
long-term ans other obligations
BALANCE SHEET RATIOS
THANK YOU!