Gibson10e ch03

Chapter 3
Balance Sheet
COPYRIGHT ©2007 Thomson South-Western, a part of the Thomson Corporation. Thomson,

the Star logo, and South-Western are trademarks used herein under license.
The Balance Sheet
• “Statement of Financial Position”
Owners'
Assets = Liabilities + Equity
• Dated as of a specific date

• Format
– Account
– Report
Chapter 3, Slide #2
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.
•Balance Sheet – Report Form
ABC Corporation
Balance Sheet
December 31, 20X6
ASSETS
Current assets $ 281,157
Plant and equipment 142,258
Goodwill 55,254
Total assets $ 478,669
LIABILITIES and STOCKHOLDERS' EQUITY

Current liabilities $ 159,926
Long-term liabilities 32,495
Total liabilities 192,421
Stockholders' equity 286,248
Total liabilities and stockholders' equity $ 478,669
Chapter 3, Slide #3
Balance Sheet – Account Form
ABC Corporation
Balance Sheet
December 31, 20X6
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
Stockholders' equity 286,248
Total liabilities and
Total assets $ 478,669 stockholders' equity $ 478,669
Chapter 3, Slide #4
Assets
• Probable future economic benefits obtained or

controlled by an entity as a result of past
transactions or events
– Current Assets
• Cash and assets that will be converted into cash during
the operating cycle or within a year, whichever is longer
• Presented in order of liquidity
– Long-term Assets
Chapter 3, Slide #5
Current Assets (cont’d)
• Cash
– Negotiable checks, unrestricted balance in checking
accounts, savings accounts
• Marketable Securities
– Debt or equity securities
– Carried at fair value
– Intention to convert into cash during the current
period
Chapter 3, Slide #6
• Accounts Receivable
– Amounts due from sales or services
– Carried at net realizable value (net of allowances)
• Other receivables due from nontrade sources
Chapter 3, Slide #7
• Inventories
– Carried at lower of cost or market
– Categories
• Goods on hand
• Raw materials
• Work in process Manufacturer
• Finished goods
Chapter 3, Slide #8
• Prepaids
– Expenditures made in advance of the use of the
service or goods.
– Examples
• Insurance
• Rent
Chapter 3, Slide #9
Long-Term Assets: Tangible
• 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
Chapter 3, Slide #10

Long-Term Assets: Tangible (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

Long-Term Assets: Tangible (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
– Depreciation methods
– Straight Line – Declining Balance
– Sum-of-the-Years’-Digits – Units of Production
• Balance sheet presentation
Cost of the asset
– Accumulated depreciation
= Net book value
Depreciation: Straight-Line Method
Cost............................. $10,000 Estimated salvage.......... $2,000
Estimated life.............. 5 years
Cost - Salvage Value
= Annual Depreciation
Estimated Life
10,000 - 2,000
= $1,600
5 years
Deprec.
for the Accumulated Book
Year Year Depreciation Asset Cost 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 The salvage value is not
5 1,600 8,000 10,000 2,000 depreciated.

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

Depreciation: Units-of-Production
Method
Estimated total hours..... 16,000
Cost - Salvage Value
= Per Unit Depreciation
Estimated Life in Capacity
10,000 - 2,000
= $0.50
16,000 hours
• Hours of Operation × Rate = Depreciation

• Asset is depreciated until salvage value is
reached

Long-Term Assets: Leases
• Capital lease
– In-substance ownership
– Recorded as an asset net of amortization

Long-Term Assets: Investments
• Debt or equity securities

– Held to maintain business relationship or to exercise control
• Debt classification
– Held-to-maturity carried at amortized cost
– Available-for-sale carried at fair value
• Equity securities
– Carried at fair value
– Exception: with the ability to exercise significant influence the
equity method is used: cost is adjusted for the proportionate
share of the rise/fall in the retained profits of the subsidiary
(investee)

Long-Term Assets: Intangibles
• Goodwill
– Purchase of a business where price paid exceeds the fair
value of net assets
– U.S. GAAP: not amortized; test annually for impairment
• Patents
– 20 years
– Amortized over shorter of legal or useful life
• Trademarks
– Indefinite legal life
– Not amortized; test annually for impairment

Long-Term Assets: Intangibles (cont’d)
• Franchises
– 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

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
– Current Liabilities
• Obligations whose liquidation is reasonably expected
within one year or the operating cycle, whichever is longer
– Long-term Assets

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

Long-Term Liabilities
• Due in a period beyond one year or operating

cycle
• Related to
– Financing arrangements
– Operational obligations

Long-Term Liabilities: 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

Long-Term Liabilities: Financing
Arrangements (cont’d)
• Bonds Payable
– Sold at par, premium, or discount
– Premium or discount is amortized into interest
expense
– Bond carrying value is amortized to par value
– Convertible bonds can be converted into common
stock
– Conversion feature enhances bond selling price

Bonds at Par, Premium, or Discount
Market Interest Bonds
Rate Sold at
6% Premium
Bond
Par
Contractual 8%
(Face Value)
Interest Rate 8%
10% Discount
Long-Term Liabilities: 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

Long-Term Liabilities: Operational
Obligations (cont’d)
• Minority Interest
– Reported on consolidated financial statements
– Represents the interest in the equity of a partially-held
subsidiary by the nonmajority owners
– Not a liability per se but for purposes of analysis treat as a
liability
• Other Noncurrent Liabilities
– As circumstances warrant
• Redeemable Preferred Stock
– Excluded from owners' equity
– For analysis, treat as a liability

Owners’ Equity
• The residual ownership interest in the assets of

an entity that remains after deducting its
liabilities
– Paid-in Capital
– Retained Earnings

Owners’ Equity: Paid-in Capital
• Par value
– In some states, referred to as “stated value”
– Considered “legal capital” by many states
– Established by the articles of incorporation
– Usually a minimal value
• No-par stock

Owners’ Equity: Paid-in Capital (cont’d)
• Additional paid-in capital

– Issue price in excess of par (stated) value
– Other sources
• Treasury stock transactions
• Stock dividend transactions
• Donated capital

• Common Stock
– Shareholder ownership
– Voting rights
• Election of board of directors
• Major corporate decisions
– Liquidation rights secondary to
• Creditors
• Preferred stock

• Preferred Stock
– Does not normally convey voting rights
– May carry any or all of these features:
• Preference as to dividends
• Accumulation of dividends
• Participation in dividend beyond stated dividend rate
• Convertibility into common stock at holder’s discretion
• Preference in liquidation secondary to creditors
• Callable at issuer discretion
• Redemption at future maturity value
• Donated Capital
– Donated by outside entities
– Shareholder surrender of stock

Owners’ Equity: Retained Earnings
• Undistributed earnings of the corporation

– Net income for all prior periods
– Less dividends declared to shareholders

Owners’ Equity: Other
• Quasi-Reorganization
– Eliminates a deficit balance of retained earnings
– Retained earnings are dated for 5-10 years
• Equity-Oriented Deferred Compensation
– A reduction to owners' equity that is amortized
(expensed) to future periods of employee service

Owners’ Equity: Other (cont’d)
• Employee Stock Ownership Plans (ESOPs)

– A qualified pension plan
– Tax benefits for the employer and employee
– Unearned compensation reduces owners' equity
• Treasury Stock
– Stock purchased and held by the issuing corporation
– Recording and disclosure
• Record at par value; deduct from paid-in capital
• Record at cost; deduct from total owners' equity

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

Balance Sheet Presentation Issues
• 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


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Chapter 3

COPYRIGHT ©2007 Thomson South-Western, a part of the Thomson Corporation. Thomson,

• “Statement of Financial Position”

• Dated as of a specific date

LIABILITIES and STOCKHOLDERS' EQUITY

Current assets $ 281,157 Current liabilities $ 159,926

• Probable future economic benefits obtained or

Chapter 3, Slide #10

Chapter 3, Slide #11

Chapter 3, Slide #13

Chapter 3, Slide #15

• Hours of Operation × Rate = Depreciation

Chapter 3, Slide #16

Chapter 3, Slide #17

• Debt or equity securities

Chapter 3, Slide #18

Chapter 3, Slide #19

Chapter 3, Slide #20

• Probable future sacrifices of economic benefits

Chapter 3, Slide #21

Chapter 3, Slide #22

• Due in a period beyond one year or operating

Chapter 3, Slide #23

Chapter 3, Slide #24

Chapter 3, Slide #25

Chapter 3, Slide #27

Chapter 3, Slide #28

• The residual ownership interest in the assets of

Chapter 3, Slide #29

Chapter 3, Slide #30

• Additional paid-in capital

Chapter 3, Slide #31

Chapter 3, Slide #32

Chapter 3, Slide #33

• Undistributed earnings of the corporation

Chapter 3, Slide #34

Chapter 3, Slide #35

• Employee Stock Ownership Plans (ESOPs)

Chapter 3, Slide #36

• Reconciles the beginning and ending balances

Chapter 3, Slide #37

• Financial analysis is complicated by

Chapter 3, Slide #38

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