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BALANCE SHEET

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.

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BALANCE SHEET

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  1. BALANCE SHEET Accounting ASW Summer 2007

  2. Assets = Liabilities + Owners’ Equity • Net Worth • Explains the components of net worth

  3. Reason for mis-valuation • Accounting omits many assets • Accounting mis-values many assets • FASB/IASB know and do it intentionally

  4. Asset Definition • Probable net future cash inflow • Currently right to it (often title) • Past transaction provided right • Future benefits reasonably quantifiable

  5. 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

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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?

  12. 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.

  13. 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

  14. Owners’ Equity • Residual (assets - liabilities)

  15. 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.

  16. 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

  17. 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

  18. 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

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