CH 3

Chapter
Balance Sheet:
The Statement of Financial
Position
2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for
classroom use.
Balance Sheet
Now statement of financial position
Shows financial condition as of a specific date
The accounting equation expresses the
relationship among elements of balance sheet
Assets = Liabilities + Shareholders Equity
Format
Account form (side by side)
Report form (assets at top and liabilities and
Shareholders equity at bottom) dominant in the U.S.
2013 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain
product or service or otherwise on a password-protected website for classroom use.
Assets
Probable future economic benefits obtained or
controlled by an entity
May be physical or intangible
Major categories
Current Assets
Includes cash, and assets that will be realized in cash during
the operating cycle or one year which ever is longer
Noncurrent or Long-term Assets

Includes assets that take longer than one year or operating
cycle to convert or to conserve cash
Current Assets
Cash and assets that will be converted into cash
(or expired) during the operating cycle or within
a year, whichever is longer
Presented in order of liquidity (either way!)
Cash
Includes negotiable checks, unrestricted balance in
checking accounts, cash on hand, savings accounts
Current AssetsContinued
Marketable Securities (ST-Investments)
readily determinable market price
Debt or equity securities
Carried at fair value
To be converted into cash during the current period
Receivables (trade/nontrade)
Amounts due from sales or services rendered

Carried at net realizable value (net of allowances)
All allowances are carried in one allowance account
Other receivables due from nontrade sources
Inventories
Balance of goods on hand
Categories
Merchandise on handretail or wholesale firms

Raw materials
Work in process
Manufacturer
Finished goods
Carried at the lower of cost or market

Supplies could include register tapes, pencils, or
sewing machine needles for the shirt factory
Prepaids
Expenditures made in advance of the use of the
service or goods
Represent future benefits resulting from past
transactions
Examples
Insurance
Advertising
Taxes
Promotion costs
Early payments on long-term contracts
Long-Term (Noncurrent) Assets: Tangible

or Intangible
PP&E: long-lived, tangible & used in operations.
Land
Carried at acquisition cost (or revaluation model IFRS)
Not subject to depreciation
Natural resources are depleted (separate from land)
Buildings
Presented at cost plus permanent improvements
Depreciated over their estimated useful life
Long-Term Assets: TangibleContinued

Machinery
Historical cost, including costs of delivery, installation,
and material improvements
Depreciated over its useful life
Construction in Progress
Assets under construction
Classified under Other Long-Term Assets (to avoid
distortion to Operating Assets analysis)
Costs will be transferred to permanent asset account
upon completion

Accumulated Depreciation
Carries the to-date depreciation of plant assets
It is subtracted from the cost of the asset to determine
the book value
Factors used in depreciation calculation
Asset cost
Length of the life of the asset
Estimated salvage (residual) value of asset when retired

Depreciation Methods
Straight-line
Declining-balance
Sum-of-the-years-digits
Units-of-production
Balance Sheet Presentation

Cost of the asset
Less: Accumulated depreciation
Net book value
Depreciation: Straight-Line Method

Cost of asset
$10,000
Estimated salvage $ 2,000
Estimated life
5 years
Cost Salvage Value
= Annual Depreciation
Estimated Value
$10, 000 $2, 000
$1, 600
5 Years
Depreciation: Straight-Line Method

Continued
The salvage value is not depreciated and it
equals book value at end of useful life
Depreciation for
Year
Year
Accumulated
Depreciation at
End of Year
Cost
Book Amount
at End of Year
$1,600
$1,600
$10,000
$8,400
1,600
3,200
10,000
6,800
1,600
4,800
10,000
5,200
1,600
6,400
10,000
3,600
1,600
8,000
10,000
2,000
Depreciation: Declining-Balance Method

Cost
$10,000
Estimated life
5 years
1
2 = Double the straight-line rate*
Estimated Life
1
2 Book Value at Beginning of Year = Annual Depreciation
5
*Double the straight-line rate is the maximum rate
Depreciation: Declining-Balance Method

Continued
Salvage value is not used in the depreciation
formula but depreciation ends when the book
value equals the salvage value
Year Cost
1 $10,000
Accumulated Book Amount

Book
Depreciation at at Beginning Depreciation Amount at
Beg. of Year
of Year
for Year End of Year
$10,000
$4,000
$6,000
10,000
$4,000
6,000
2,400
3,600
10,000
6,400
3,600
1,440
2,160
10,000
7,840
2,160
160
2,000
10,000
8,000
2,000
2,000
Depreciation:
Sum-of-the-Years-Digits Method
Cost
$10,000
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
(5 4 3 2 1) or 15
Depreciation: Sum-of-the-Years-Digits
MethodContinued
Cost Less
Accumulated
Book
Depreciation
Year Salvage Fraction
Depreciation at End Amount at
for Year
Value
of Year
End of Year
1
$8,000
5/15
$2,666.67
$2,666.67
$7,333.33
8,000
4/15
2,133.33
4,800.00
5,200.00
8,000
3/15
1,600.00
6,400.00
3,600.00
8,000
2/15
1,066.67
7,466.67
2,533.33
8,000
1/15
533.33
8,000.00
2,000.00
Depreciation:
Units-of-Production Method
Cost
$10,000
Estimated salvage
$ 2,000
Estimated total hours 16,000
Actual hours of operation
2,000
Cost Salvage Value
Per Unit Depreciation
Estimated Life in Capacity
10,000 2,000
= $0.50
16,000 Hours
Depreciation: Units-of-Production Method

Continued
Actual Hours of Operation Rate = Depreciation
2,000 hours $0.50 = $1,000
Therefore, the depreciation expense for year one is
$1,000
Asset is depreciated until book value equals

salvage value
Depreciation: Implication on analysis

Different methods produce different expenses
(I/S) and different contra asset account balance
(SFP). Net Income and Total Assets are affected.
Accelerated methods produce greater
depreciation expense in early years (postpone
taxes)
Long-Term Assets: Leases

Capital Lease (in contrast to operating lease)
It is in-substance an ownership arrangement
Classified as long term asset;
shown net of amortization
Long-Term Assets: Investments

Debt or Equity Securities
Held to maintain business relationship or to exercise
control
Debt Securities Classification

Held-to-maturity securities are carried at amortized
cost
Available-for-sale securities are carried at fair value
Long-Term Assets: Investments

Continued
Equity Securities
Carried at fair value which have 3 levels for input
Level 1: Quoted price for identical item in active market
Level 2: Adjusted quoted price of similar asset (or liability)
Level 3: Present value of expected cash flows
Exception- Equity method is used where there is

significant influence
Cost is adjusted for the proportionate share of the rise/fall in
the retained profits of the subsidiary (investee)
Long-Term Assets: Intangibles

Intangibles nonphysical +nonmonetary
They are recorded at historical cost
Purchased or developed (capitalised)
An intangible asset that has a finite life is
amortized over its useful life
An intangible asset with an indefinite life are
revalued for impairment
Long-Term Assets: Intangibles

Continued
Goodwill
Patents
Trademarks/Tradenames
Franchises/Licenses
Copyrights
Intangibles with finite lives = amortise.
Intangibles with indefinite lives = review annually
Other Noncurrent Assets

Few assets do not fit into any of the previously
discussed classification
Include noncurrent receivables and noncurrent
prepaids
Current Liabilities
Obligations whose liquidation is reasonably
expected within one year or the operating cycle,
whichever is longer
Require
Use of existing current assets
Creation of other current liabilities
Include
Payables
Unearned Income
Other Current Liabilities
Long-Term Liabilities
Due in a period beyond one year or operating
cycle, whichever is longer
Types
Financing arrangements of assets
Operational obligations
Liabilities Relating to Financing

Agreements
Notes Payable
Promissory notes
If secured by property, they are called mortgage notes
Credit Agreements
Ready lines of credit

Not a liability until funds are drawn
Positive sign
Disclosure of the unused portion
HERE>>Liabilities Relating to Financing

AgreementsContinued
Bonds Payable
Sold at par, premium, or discount
Premium or discount is amortized
Bond carrying value is amortized to par value
Convertible bonds can be converted into ordinary
shares (implications on EPS?)
Conversion feature enhances the bonds selling price
Exhibit 3-13Bonds at Par, Premium, or

Discount
Liabilities Relating to Operational

Obligations
Deferred Taxes (in US!!)
Warranty Obligations
Estimated obligations arising out of product
warranties
Estimated to recognize the obligation at the balance
sheet date and to charge expense
Equity:
Noncontrolling Interest
Previously called minority interest
Reflects the ownership of noncontrolling shareholders
in the equity of consolidated subsidiaries less than
wholly owned
Reported on consolidated financial statements as
equity, but separate from parents equity
If material, analysis can be performed twice
Once as a liability to be conservative and then as
shareholders equity item
HERE>>Liabilities Relating to Operational

ObligationsContinued
Other Noncurrent Liabilities
Redeemable Preferred Stock (option of holder)
Excluded from Shareholders equity
For analysis, treated as a liability
Shareholders Equity
Also called Stockholders Equity
The residual ownership interest in the assets of
an entity that remains after deducting its
liabilities
Share capital
Retained earnings
Other Reserves
Shareholders Equity: Share Capital

(Paid-In Capital (PIC))
Two basic types of Share Capital
Ordinary (common)
Preference (Preferred)
Par value
In some states, referred to as stated value stock

Considered legal capital by many countries
Established by the articles of incorporation
Usually a minimal value (in Jordan = JD1)
Shareholders Equity:
Share CapitalContinued
Share Premium (Additional PIC)
Issue price in excess of par (stated) value
Other sources such as Treasury shares transactions
Shareholders Equity: Ordinary Shares

Shareholder ownership
Voting rights
Election of board of directors
Major corporate decisions (dividends policy, off-shore
expansion..)
Liquidation rights secondary to

Creditors
Preferred Shareholders
Shareholders Equity: Preferred Share

Does not normally convey voting rights
May carry any or all of these features:
Preference as to dividends
Accumulation of dividends
Participation in excess of stated dividend rate
Convertibility into common stock at holders discretion
Callability by the corporation (option to issuer)
Redemption at future maturity date (option to holder)
Preference in liquidation secondary to creditors
Shareholders Equity: Donated Capital

May be included in the Share Capital
Donated by outside entities
Example: Shareholder surrender of stock,
donation of land..
Shareholders Equity: Retained Earnings

Undistributed earnings of the corporation
Net income for all prior periods
Less dividends (both cash and stock) declared to
shareholders
Shareholders Equity: Others

Quasi-Reorganization (Deficit Reclassification)
Eliminates a deficit balance of retained earnings and
an equal amount from Share Premium
Retained earnings dated as of the readjustment date
and disclosed in the financial statements for a period
of five to ten years
Accumulated Other Comprehensive Income

Represents retained earnings from other
comprehensive income (Unrealised Gains/Losses)
Disclosed as a separate component on the face of the
balance sheet or in the notes
Shareholders Equity: OthersContinued

Employee Stock Ownership Plans (ESOPs)
A qualified stock-bonus plan, or a combination of
stock-bonus and money-purchase pension plan
Tax benefits for the employer and employee
Unearned compensation decreases Shareholders
equity
Shareholders Equity: OthersContinued

Treasury Stock
Stock purchased and held by the issuing corporation
Record treasury stocks in two ways
Par-value method
Cost method
Presented as a reduction of Shareholders equity)

Most firms record treasury stock at cost
Statement of Shareholders Equity

Changes in Shareholders equity accounts
Issuance of stock increases paid-in capital

Acquisition of treasury stock increases treasury stock
Net income increases retained earnings
Dividends decreases retained earnings
Problems 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 product to product
Within an industry from firm to firm
Not all items of value are listed as assets

Certain contingent liabilities may be excluded
International Consolidated Balance

Sheet (IFRS)
Asset section
Usually noncurrent assets are presented first,
followed by current assets
Liabilities and Owners Equity section

Capital and reserves are usually listed first, then
noncurrent liabilities, and at last, current liabilities
The reserves sections of capital and reserves would not be
part of U.S. GAAP

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Chapter

Noncurrent or Long-term Assets

Amounts due from sales or services rendered

Merchandise on handretail or wholesale firms

Carried at the lower of cost or market

Long-Term (Noncurrent) Assets: Tangible

Long-Term Assets: TangibleContinued

Long-Term Assets: TangibleContinued

Long-Term Assets: TangibleContinued

Balance Sheet Presentation

Depreciation: Straight-Line Method

Depreciation: Straight-Line Method

Depreciation: Declining-Balance Method

2 = Double the straight-line rate*

2 Book Value at Beginning of Year = Annual Depreciation

Depreciation: Declining-Balance Method

Accumulated Book Amount

Depreciation: Units-of-Production Method

Asset is depreciated until book value equals

Depreciation: Implication on analysis

Long-Term Assets: Leases

Long-Term Assets: Investments

Debt Securities Classification

Long-Term Assets: Investments

Exception- Equity method is used where there is

Long-Term Assets: Intangibles

Long-Term Assets: Intangibles

Other Noncurrent Assets

Liabilities Relating to Financing

Ready lines of credit

HERE>>Liabilities Relating to Financing

Exhibit 3-13Bonds at Par, Premium, or

Liabilities Relating to Operational

HERE>>Liabilities Relating to Operational

Shareholders Equity: Share Capital

In some states, referred to as stated value stock

Shareholders Equity: Ordinary Shares

Liquidation rights secondary to

Shareholders Equity: Preferred Share

Shareholders Equity: Donated Capital

Shareholders Equity: Retained Earnings

Shareholders Equity: Others

Accumulated Other Comprehensive Income

Shareholders Equity: OthersContinued

Shareholders Equity: OthersContinued

Presented as a reduction of Shareholders equity)

Statement of Shareholders Equity

Issuance of stock increases paid-in capital

Problems in Balance Sheet Presentation

Not all items of value are listed as assets

International Consolidated Balance

Liabilities and Owners Equity section

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