Balance Sheets

AuthorJohn Alvis, Laurie Hillstrom
Pages27-30

Page 27

The balance sheet, also known as the statement of financial position, is a snapshot of a company's financial condition at a single point in time. It presents a summary listing of a company's assets, liabilities, and owners' equity. The balance sheet is prepared as of the last day of the business year. Therefore, it corresponds to the end of the time period covered by the income statement.

To understand the balance sheet, its purpose, and its contents, several accounting concepts need to be examined. First of all, the balance sheet represents the accounting equation for a company. The accounting equation is a mathematical expression that states the following:

Assets = Liabilities + Owners' Equity

Stated more fully, this means that the dollar total of the assets equals the dollar total of the liabilities plus the dollar total of the owners' equity. The balance sheet presents a company's resources (i.e., assets, or anything the company owns that has monetary value) and the origin or source of these resources (i.e., through borrowing or through the contributions of the owners). By expressing the same dollar amount twice (once as the dollar total of the assets, then as the dollar total of where the assets came from or who has an equity interest in them), we see that the two amounts must be equal or balance at any given point in time.

An interesting observation about the balance sheet is the valuation at which assets are presented. The average person would assume that the assets listed on the balance sheet would be shown at their current market values. In actuality, generally accepted accounting principles require that most assets be recorded and disclosed at their historical cost, or the original amount that the company paid to obtain ownership or control of the assets. As time passes, however, the current value of certain assets will drift further and further away from their historical cost. In an attempt to present useful information, financial statements show some assets (for which there is a definite market value) at their current market value. When there is no specific market value, historical values are used. An expanded discussion of this concept will follow.

A simple example of a balance sheet appears in Table 1.

ASSETS

As a category, assets include current assets, fixed or long-term assets, property, intangible assets, and other assets.

CURRENT ASSETS

Assets can be viewed as company-owned or controlled resources, from which the organization expects to gain a future benefit. Examples of assets for a typical company include cash, receivables from customers, inventory to be sold, land, and buildings. In order to make the balance sheet more readable, assets are grouped together based on similar characteristics and presented in totals, rather than as a long list of minor component parts.

The first grouping of assets is current assets. Current assets consist of cash, as well as other assets that will probably be converted to cash or used up within one year. The one-year horizon is the crucial issue in classifying assets as current. The concern is to

Page 28

Table 1

Sample Balance Sheet

Assets Liabilities and Owners' Equity
Current assets 600,000 Current liabilities 280,000
Fixed Assets 90,000 Long-term debt 500,000
Property 800,000 Owners' equity 900,000
Intangible assets 50,000
Other assets 140,000
TOTAL ASSETS 1,680,000 TOTAL LIABILITIES AND OWNERS' EQUITY 1,680,000

present assets that will provide liquidity in the near future. Current assets should be listed on the balance sheet in the order of most liquid to least liquid. Therefore, the list of current assets begins with cash. Cash includes monies available in checking accounts and any cash on-hand at the business that can be used immediately as needed. Any cash funds or temporary investments that have restrictions on their withdrawals, or that have been set up to be spent beyond one year, should not be included in current assets.

Temporary investments known as trading securities are short-term investments that a company intends to trade actively for profit. These types of investments—common to the financial statements of insurance companies and banks—are shown on the balance sheet at their current market value as of the date of the balance sheet. Any increase or decrease in market value since the previous balance sheet is included in the calculation of net income on the income statement.

The next category on the list of current...

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