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AFM Chapter 2 Balance Sheet
AFM Chapter 2 Balance Sheet
Basic Accounting
Concepts: The
Balance Sheet
2-2
11 Basic Concepts
1. Money measurement.
2. Entity.
3. Going concern.
4. Cost.
5. Dual aspect.
6. Accounting period.
7. Conservatism.
8. Realization.
9. Matching.
10.Consistency.
11.Materiality.
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Concept #1:
Money Measurement
• Accounting records are recorded in
monetary terms at value at time
transaction is recorded.
• Severe limitation.
– Some items can’t be easily valued.
• E.g., president’s health, effect of strike.
– Price changes ignored.
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Concept #2: Entity
2-6
Concept #4: Cost
Terminology
• Assets.
– economic resources of an entity.
– recorded at cost (i.e., price paid).
• Book value of assets.
– recorded value.
• Fair value of assets.
– amount for which asset could be currently
purchased or sold..
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Cost Concept
Non-monetary Assets
• E.g., land, buildings, machinery and similar.
– Maintain in accounting records at book value.
– Generally, book value = fair value only at time of
acquisition.
• Depreciation (or amortization).
– Systematic allocation of cost over life of asset.
• Book value: Recorded cost minus depreciation to
date.
• Rationale: Relevance sacrificed for objectivity.
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Cost Concept: Monetary
Assets
• E.g., cash, marketable securities.
• Initially recorded at cost and then adjusted to
fair value.
• Rationale: Fair value is relevant, objective, and
feasible.
• Question: Why is fair value relevant and objective
for monetary assets (e.g., marketable securities) but
not for non-monetary assets (e.g., building)?
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Cost Concept: Goodwill
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Dual Aspect
• For a corporation:
Assets = Liabilities + Stockholders’ equity
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Dual Aspect
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Balance Sheet
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Balance Sheet
Resources and Claims View
• Assets.
– how funds were used or invested.
• Liabilities + owners’ equity.
– sources of funds.
– how assets were financed.
2-16
Account Categories
• Groups of related items.
• Main categories.
– Assets.
– Liabilities.
– Owners’ (shareholders’) equity.
– Revenues.
– Expenses.
• Discretion of management.
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Assets
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Current Assets
• Cash.
– Funds available for disbursement.
• Other assets expected to be realized in
cash, or sold, or consumed, within one
year.
– Or normal operating cycle, if longer.
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Current Assets:
Marketable Securities
• Investments that are:
– Readily marketable, AND,
– Expected to be converted to cash within
one year.
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Current Assets:
Accounts (and Notes) Receivable
• Accounts Receivable:
– Owed by customers.
– Reported at amount owed less an
estimated uncollectible amount.
• Notes (Other) receivables:
– Owed by other than customers.
– Evidence by written promises to pay
(notes).
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Current Assets:
Inventories
• Items that are:
– Held for sale in ordinary course of business,
– In process of production for sale, or
– To be consumed in production of goods or
services to be sold.
• Question: Is a truck inventory?
– To Ford Motor Company = Inventory.
– To Home Builder = Equipment (Noncurrent Asset).
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Current Assets:
Prepaid Expenses
• Intangible.
• Usefulness will expire in near future.
• Examples:
– Prepaid rent expense.
– Prepaid insurance expense.
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Property, Plant, and
Equipment
• Also, called fixed assets.
• Tangible, long-lived.
• Used to produce goods and services to
generate cash inflows.
• Land is not depreciated.
• Building and equipment shown at:
– Cost less accumulated depreciation.
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Other Assets
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Liabilities
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Current Liabilities:
Accounts (and Notes) Payable
• Accounts Payable:
– Suppliers (i.e. vendors) claims for goods or
services furnished, but not yet paid.
– Unsecured.
• Notes payable:
– Short-term loans.
– Formal written note.
– Includes amounts owed to financial institutions.
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Current Liabilities:
Taxes Payable
• Owed to government agencies for taxes.
• Income taxes often shown separately
because of size.
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Current Liabilities:
Accrued Expenses
• Earned by outside parties but not yet
paid (i.e., unpaid expenses).
• Usually no invoice.
• Includes interest payable, wages
payable.
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Current Liabilities:
Deferred Revenues
• Also called unearned revenues or pre-
collected revenues.
• Advance payment received, but company
has not yet performed service or
delivered product.
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Current Liabilities:
Current Portion of Long-Term Debt
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Long-Term Liabilities
• Also called:
– Long-term debt.
– Non-current liabilities.
• Due beyond upcoming year.
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Owners’ Equity
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Shareholders’ Equity:
Paid-in Capital
• Amount owners have paid in to purchase
shares of stock.
• Classified as:
– Par value.
– Additional paid-in capital.
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Shareholders’ Equity:
Retained Earnings
• Reinvested earnings from inception to
date less dividends to date.
• If negative, amount labeled as deficit.
• Question: Is Retained Earnings the same
as Cash?
– No, does not indicate the form of
reinvestment.
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Unincorporated Businesses
• Proprietorship.
– Business owned by one person.
• Partnership.
– Business owned jointly by two or more
persons.
– Utilize a Capital account for each partner.
– Capital account decreased by withdrawals
by each owner (i.e., drawings).
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Financial Statement Ratios
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