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

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

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

Contra Accounts Accumulate reductions in accounts Often used to separate historical cost from book value Accumulated Depreciation - Contra-asset offsetting PP&E at cost - Credit balance Allowed for Doubtful Accounts - Contra to accounts receivable