Balance Sheet(Quick Test #2 with Coaching)

The balance sheet is also known as the statement of financial position.

The accrual method of accounting will result in the reporting of current assets and current liabilities that would not be reported under the cash method. Examples include accounts receivable, interest receivable, prepaid expenses, accounts payable, accrued liabilities, interest payable, deferred revenues, and others.

The balance sheet reports the account balances in the asset, liability, and owner's (stockholders') equity accounts as of the final moment of the accounting year (or any other point in time).

The balance sheet of a corporation has the following sections: assets, liabilities, and stockholders' equity (or shareholders' equity).

Note that the balance sheet has the same outline as the accounting equation for a corporation: Assets = Liabilities + Stockholders' Equity

The claims to a corporation's assets are generally in this order: secured liabilities, unsecured liabilities, stockholders' equity. Hence, stockholders' equity is said to be a residual claim.

The operating cycle for a retailer is the time it takes for the retailer to obtain merchandise, sell the merchandise, and collect the money. The operating cycle is often a few months. Therefore, it is common for people to use one year in determining when assets and liabilities are current versus noncurrent.

In an industry where the operating cycle is longer than one year, the company will use the length of the operating cycle to determine when assets and liabilities are current versus noncurrent.

The current assets are usually listed in their order of liquidity. This means that cash is listed first followed by temporary investments, accounts receivable, inventory, prepaid expenses.

A cash equivalent will generally have a maturity date of 3 months or less. Hence, the U.S. Treasury note maturing in 8 months will not qualify as cash or cash equivalent.

The net realizable value (NRV) of accounts receivable is the debit balance in Accounts Receivable minus the credit balance in the account Allowance for Doubtful Accounts.

Accounts receivable are also known as trade receivables, which result from a company's sales to customers on credit.

Since the advance to an employee does not qualify as a trade receivable, the amount owed to the company by the employee would be better classified as one of the company's other receivables (or miscellaneous receivables).

A retailer's inventory has to be valued at its cost because of the cost principle. (Cost includes the amount paid to the supplier plus all costs necessary to get the merchandise in place and ready for sale. For example, freight-in is part of the inventory cost.)

At December 31 $2,500 of unexpired insurance cost should be deferred to the current asset section of the balance sheet as Prepaid Insurance or as part of Prepaid Expenses.

Each month an adjusting entry will move $500 from Prepaid Insurance to Insurance Expense to recognize that the insurance coverage has a monthly cost of $500.

Retained earnings represents the amounts earned since the time the corporation was formed minus the dividends declared by the corporation since the time the corporation was formed. These undistributed earnings are reported as retained earnings and included as a separate line in the stockholders' equity section of the balance sheet.

It is unlikely that the amount of retained earnings will be in the corporation's checking account. Often the retained earnings will end up in long-term assets as a profitable corporation seeks to expand or improve its business operations. Some corporations will use retained earnings to reduce its debt or to purchase some of its outstanding shares of stock.

The only contra asset in the list is Accumulated Depreciation. As a contra asset account, it will be credited for each period's depreciation. (The debit will likely be entered in Depreciation Expense.)

The other accounts appearing in the list are contra liability or contra owner's equity accounts.

The book value or carrying value of equipment used in a business is the equipment's cost minus the equipment's accumulated depreciation.

The depreciation reported on the financial statements reflects the accountant's matching principle.

On the other hand, the depreciation on the income tax return reflects the IRS income tax regulations.

Therefore, unless the assets are fully depreciated, the tax and book amounts will likely be different.

For example, a corporation may calculate the financial statement's depreciation of its equipment using a useful life of 10 years. However, the income tax regulations may require that the depreciation on the income tax return be calculated using 7 years. (Sometimes the tax depreciation can be taken even faster.)

The differences between accounting principles and tax regulations will generally mean that the tax and book balance sheets will be reporting different amounts for accumulated depreciation.

Trade names, patents, and goodwill are referred to as intangible assets. Even though they are not tangible, these can be the most valuable assets that a corporation possesses.

The trade names will only be reported on the balance sheet if they had a cost. If a company developed its trade names through effective marketing and great products, the trade names will not be reported on the balance sheet.

Under the accrual method of accounting, an expense and the related liability should be increased when they are incurred. The expense causes a decrease in net income and also causes stockholders' equity (specifically retained earnings) to decrease.

This situation usually requires a corporation to record an adjusting entry prior to issuing its financial statements. Since the repair expense (and the liability) occurred prior to receiving the bill or paying the supplier, the adjusting entry is referred to as an accrual adjusting entry. The adjusting entry will debit Repairs Expense and will credit a liability account such as Accrued Expenses Payable or Accrued Liabilities.

Since the store has not earned any revenues from providing goods or services, the amount received must be deferred to a later accounting period when the gift cards are used.

The deferral is reported as a liability since the store has received the $10,000 and it has an obligation to provide the goods or services.

The principal balance that has not been repaid will be divided into two amounts. The total of the next 12 monthly principal payments should be reported as a current liability.

The unpaid principal balance minus the principal payments included in the next 12 monthly payments should be reported as a long-term or noncurrent liability.

The balance sheet liabilities include amounts that are owed as of the date of the balance sheet. Future interest has not yet occurred and therefore is not yet owed as of the date of the balance sheet. Hence, future interest is not reported on the balance sheet.

Working capital is defined as: current assets minus current liabilities. Therefore, the working capital is $35,000 calculated as: current assets of $215,000 minus current liabilities of $180,000.

The corporation's reported amount of stockholders' equity reflects the accounting principles such as the cost principle. Hence, the reported amount of stockholders' equity is equal to the reported amount of assets minus the reported amount of liabilities.

It is likely that the FMV of a constant stream of $400,000 or more of annual net income is worth far more than the reported stockholders' equity of $515,000. (I suspect that many investors would say the FMV is perhaps $2,000,000.)

In financial leverage ratios such as debt to equity or debt to assets, debt means total liabilities.

The greater the proportion of debt means the greater the financial leverage. This in turn means more risk and perhaps a greater percentage of gain or a greater percentage of loss.

When a corporation pays one of its accounts payable, the asset account Cash is reduced and the liability account Accounts Payable is reduced. Therefore, working capital will NOT change.

To illustrate, let's assume that before the corporation pays one of its accounts payable, its Cash balance was $900 and its Accounts Payable balance was $400. Also assume that these are the only current asset and current liability. Therefore, the corporation's working capital was $500 ($900 - $400).

Now let's assume that the corporation pays one of its accounts payable $300. After the payment, the corporation's Cash balance will be $600 ($900 - $300) and its Accounts Payable balance will be $100 ($400 - $300). As a result, the corporation's working capital will be $500 ($600 - $100).

Stockholders' equity will not change since there is no effect on revenues, expenses or net income.

When a corporation earns revenues, typically the asset accounts receivable or cash will increase and stockholders' equity (specifically retained earnings) will increase.

The amounts on the balance sheet are the ending balances in the asset, liability, and owner's equity accounts. Four of many examples include Cash, Accounts Receivable, Accounts Payable, R. Smith, Capital. The balances in these accounts do not go away simply because we start a new accounting period. Since these balances are carried forward to the next accounting period, these accounts are referred to as permanent or real accounts.

Since other comprehensive income is not part of net income, the amount cannot be included in retained earnings. Instead the amount of other comprehensive income will cause a change in accumulated other comprehensive income, which is part of stockholders' equity.

It is impossible to express all of the complexities of a business in the relatively few amounts reported on the face of the financial statements. In addition, the amounts are dependent on the corporation's accounting policies and on future events that may or may not occur. To bring more light on the amounts being reported, it is required that the annual external financial statements include notes to expand on the amounts.

Hence, at the bottom of each of the financial statements there should be a notation that informs the reader that the accompanying notes are an integral part of the financial statements.

The annual report to the Securities and Exchange Commission (SEC) is known as the "10-K" or Form 10-K. It contains the audited financial statements and supplementary data, management's discussion and analysis of financial condition and the results of operations, plus other information on the business, business risks, and more.