Introduction to Financial Reporting

1. Chapter 3
Balance sheet

2. 2
• “Statement of Financial Position”
• It show financial position of business over a
period of time
• Dated: as of a specific date
• Format: It is prepared in two forms:
1. Account form
2. Report form
The Balance Sheet
Owners'
Assets = Liabilities +
Equity

3. 3
1. Report Form
(One-column)
Current assets 281,157
$
Plant and equipment 142,258
Goodwill 55,254
Total assets 478,669
$
Current liabilities 159,926
$
Long-term liabilities 32,495
Total liabilities 192,421
Stockholders' equity 286,248
Total liabilities and stockholders' equity 478,669
$
LIABILITIES and STOCKHOLDERS' EQUITY
ABC Corporation
Balance Sheet
December 31, 20X6
ASSETS

4. 4
2. Account Form
(two-columns)
Current assets 281,157
$ Current liabilities 159,926
$
Plant and equipment 142,258 Long-term liabilities 32,495
Goodwill 55,254 Total liabilities 192,421
Owners' equity 286,248
Total assets 478,669
$
Total liabilities and owners'
equity 478,669
$
ABC Corporation
Balance Sheet
December 31, 20X6

5. 5
Assets
• Probable future economic benefits obtained or
controlled by an entity as a result of past
transactions or events
• Two main categories:
1. Current Assets
• Cash and assets that will be converted into cash during
the operating cycle or within a year
• Presented in order of liquidity
Liquidity is the efficiency or ease with which an asset can
be converted into cash without affecting its market price.
2. Fixed (Long-term) Assets

6. 6
Current Assets (cont’d)
• Cash
– Negotiable checks, unrestricted balance in checking
accounts, savings accounts
A negotiable instrument is a signed document that promises a
sum of payment to a specified person or the assignee.
• Marketable Securities
– Debt or equity securities
Equity securities are financial assets that represent shares of a
corporation.
Debt securities are financial assets that define the terms of a
loan between an issuer (borrower) and an investor (lender).

7. 7
Current Assets (cont’d)
• Accounts Receivable
– Amounts due from sales or services
– Carried at net realizable value (net of allowances)
• Other receivables due from nontrade sources
– Ex. Sale of old machineries, equipment etc.

8. 8
Current Assets (cont’d)
• Inventories
– Carried at lower of cost or market price
– Categories
• Goods on hand
• Raw materials
• Work in process
• Finished goods
Manufacturer

9. 9
Current Assets (cont’d)
• Prepaids
– Expenditures made in advance of the use of the
service or goods.
– Examples
• Insurance
• Rent
• Fee
• Repair and maintenance charges

10. 10
Fixed (Long-Term Assets)
• Land
– Carried at acquisition cost
– Not subject to depreciation
Natural resources are depleted as mined
• Buildings
– Cost plus permanent improvements
– Depreciated over the useful life

11. 11
Fixed (Long-Term Assets) (cont’d)
• Machinery
– Acquisition cost plus costs of delivery, installation,
and permanent improvements
– Depreciated over the useful life
• Construction in Progress
– Assets under construction
– Transferred to permanent asset account upon
completion

12. 12
Fixed (Long-Term Assets) (cont’d)
• Accumulated Depreciation
– Carries the to-date depreciation of plant assets
Factors used in depreciation calculation
• Asset cost
• Length of the life of the asset
• Estimated salvage (residual) value of asset when retired

13. 13
Long-Term Assets: Tangible (cont’d)
• Depreciation methods:
1. Straight Line
2. Declining Balance
3. Sum-of-the-Years’-Digits
4. Units of Production
• Asset presented in Balance sheet
Cost of the asset
– Accumulated depreciation
= Net book value

14. 14
Depreciation: Straight-Line Method
Cost - Salvage Value
= Annual Depreciation
Estimated Life
10,000 - 2,000
= $1,600
5 years
Cost............................. $10,000
Estimated salvage.......... $2,000
Estimated life.............. 5 years
Year
Deprec.
for the
Year
Accumulated
Depreciation Asset Cost
Book
Value
1 $1,600 $1,600 $10,000 $8,400
2 1,600 3,200 10,000 6,800
3 1,600 4,800 10,000 5,200
4 1,600 6,400 10,000 3,600
5 1,600 8,000 10,000 2,000 The salvage value is not
depreciated.
8,000

15. 15
Depreciation: Declining-Balance Method
1
2 = double the straight-line rate
Estimated Life
1
2 Book Value at Beginning of Year = Annual Depreciation
5

 
Year
Asset
Cost
Beginning
Accum.
Dep.
Beginning
Book Value
Deprec. for
the Year
Ending
Book
Value
1 $10,000 $0 $10,000 $4,000 $6,000
2 10,000 4,000 6,000 2,400 3,600
3 10,000 6,400 3,600 1,440 2,160
4 10,000 7,840 2,160 160 2,000
5 10,000 8,000 2,000 - 2,000
Scrap value is not
used in the formula,
but depreciation
ends when the book
value is equal to the
salvage value.
Cost............................. $10,000
Estimated salvage.......... $2,000
Estimated life.............. 5 years
Double the straight-line
rate is the maximum rate

16. 16
Depreciation: Sum-of-the-Years’-Digits Method
Cost............................. $10,000
Estimated salvage.......... $2,000
Estimated life.............. 5 years
 
 
 
Number of Remaining Years
Cost - Salvage = Annual Depreciation
Sum of Digits of Estimated Life
5
10,000 - 2,000 = $2,666.67
1+2+3+4+5


Year
Cost Minus
Salvage Fraction
Deprec. for
the Year
Ending Accum.
Dep.
Ending Book
Value
1 $8,000 5/15 $2,666.67 2,666.67
$ 7,333.33
$
2 8,000 4/15 2,133.33 4,800.00 5,200.00
3 8,000 3/15 1,600.00 6,400.00 3,600.00
4 8,000 2/15 1,066.67 7,466.67 2,533.33
5 8,000 1/15 533.33 8,000.00 2,000.00

17. 17
Depreciation: Units-of-Production
Method
Cost - Salvage Value
= Per Unit Depreciation
Estimated Life in Capacity
10,000 - 2,000
= $0.50
16,000 hours
Cost...................................................... $10,000
Estimated salvage................................$2,000
Estimated units to be produced.............16,000
• Units produced × Rate = Depreciation
• Asset is depreciated until salvage value is reached

18. 18
Long-Term Assets: Investments
• Debt or equity securities
– Held to maintain business relationship or to exercise control
• Equity securities
– Carried at fair value

19. 19
Long-Term Assets: Intangibles
• Goodwill (Reputation)
– Purchase of a business where price paid exceeds the
fair value of net assets
– U.S. GAAP: not amortized; test annually for impairment
• Patents (A patent is an exclusive right granted for an invention)
– 20 years
– Amortized over shorter of legal or useful life
• Trademarks
– Indefinite legal life
– Not amortized; test annually for impairment

20. 20
Long-Term Assets: Intangibles (cont’d)
• Franchises
It is the right or license granted by a company (franchisor) to an
individual (franchisee) to market and/or trade products and
services in a specific area or territory.
– Life based on contract
– Amortize over shorter of legal or useful life
• Copyrights
– Life of the creator plus 70 years
– Amortize over shorter of legal or useful life

21. 21
Liabilities
• 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
• Two main categories:
– Current Liabilities
• Obligations whose liquidation is reasonably expected
within one year or the operating cycle, whichever is longer
– Long-term Liabilities

22. 22
Current Liabilities
• Payables
– Short-term obligations created by the acquisition of
goods or services
• Unearned Income/revenue
– Payments collected in advance of the performance
of services or delivery of goods (airline tickets)
• Other current liabilities

23. 23
Long-Term Liabilities
• Due in a period beyond one year or
operating cycle
• Related to
1. Financing arrangements
2. Operational obligations

24. 24
Long-Term Liabilities: 1. Financing
Arrangements
• Notes Payable
– Secured by property: Mortgage notes
• Credit Agreements
– Ready lines of credit that may require a
compensating balance
– Not a liability until funds are drawn

25. 25
Long-Term Liabilities: 2. Operational
Obligations
• Deferred Taxes
– Difference between accounting and tax methods
– Difference in the timing of recognizing revenue and
expense for accounting and tax purposes
• Warranty Obligations
– Estimated; arise from offering product warranties
– Estimated to achieve matching of sales revenue
and associated expense of warranty

26. 26
• The residual ownership interest in the assets of
an entity that remains after deducting its
liabilities
– Direct investment by owner(s)
– Paid-in Capital
– Retained Earnings
Owners’ Equity

27. 27
Owners’ Equity: Paid-in Capital
• Common Stock
– Shareholder ownership

28. 28
Owners’ Equity: Retained Earnings
• Undistributed earnings of the corporation
– Net income for all prior periods
– Less dividends declared to shareholders

29. 29
Statement of Owners’ Equity
• Reconciles the beginning and ending balances
of all components of owners' equity
• Account changes indicate
– Issuance of stock: paid-in capital increase
– Acquisition of treasury stock: treasury stock
increase
– Net income: retained earnings increase
– Dividends: retained earnings decrease

30. 30
Issues/limitations in
Balance Sheet Presentation
• Financial analysis is complicated by:
– Many assets recorded at cost rather than fair
(replacement) value
– Varying valuation methods
• Within a firm from item to item
• Within an industry from company to company
– Not all items of value are listed as assets
– Certain contingent liabilities may be excluded

31. Exercise
31
2021 2022
Other assets 6,000.00 1,000.00
Current liabilities 6,000.00 4,000.00
Common stock/paid-in capital 8,000.00 5,000.00
Property and equipment 15,000.00 14,000.00
Retained earning (Capital) 16,000.00 12,000.00
Current assets 11,000.00 8,000.00
Long-term liabilities 2,000.00 2,000.00

32. Solution
32
2021 2022
Assets
Current assets 11,000.00 8,000.00
Property and equipment, net 15,000.00 14,000.00
Other assets 6,000.00 1,000.00
Total assets 32,000.00 23,000.00
Liabilities
Current liabilities 6,000.00 4,000.00
Long-term liabilities 2,000.00 2,000.00
Total liabilities 8,000.00 6,000.00
Stockholders’ Equity
Common stock/paid-in capital 8,000.00 5,000.00
Retained earning (Capital) 16,000.00 12,000.00
Total stockholders’ equity 24,000.00 17,000.00
Total liabilities and SE 32,000.00 23,000.00
ABC company
Balance Sheet
31-Dec-22

33. Thank you
33