CHAPTER 4 CURRENT ASSETS CURRENT ASSETS THE BALANCE SHEET

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1 1 CHAPTER 4 THE BALANCE SHEET Current assets include assets that are expected to be used within one year or the operating cycle, if longer The operating cycle involves the use of cash to buy inventories, selling the inventory to create accounts receivable, and the cash collection of those receivables 2 THE OPERATING CYCLE Collections Cash Purchases Receivables Sales Inventories 3

2 4 Cash includes coins and currency on hand; bank accounts; and short-term securities Accounts receivable are amounts owed by customers An estimate of uncollectible accounts is deducted Inventory represents goods held for sale in the normal course of business Prepaid expenses are payments in advance for operating expenses, e.g., insurance and rent Investment securities are stocks and bonds held with the intent to sell within a year 5 Current assets are listed on the balance sheet in the order of their liquidity, with the most liquid assets listed first 6

3 7 LONG-TERM ASSETS Are expected to last longer than one year Common categories include investments property, plant, and equipment intangible assets other assets LONG-TERM ASSETS Long-term investments include ownership of stocks and bonds to Exercise influence over other companies (stocks) Earn income from interest (bonds) dividends (stocks) 8 LONG-TERM ASSETS Property, plant, and equipment (PP&E) are fixed assets that benefit more than one accounting period They include land, buildings, machinery, tools, furniture, and vehicles Accumulated depreciation reflects the wear and tear since the original purchase and decreases PP&E 9

4 10 LONG-TERM ASSETS Intangible assets have no physical existence, but have some intrinsic value, generally from contract rights such as patents, trademarks, copyrights, franchises, and goodwill Goodwill is only recorded when one company buys another and pays more than the fair value of the identifiable assets CURRENT LIABILITIES Are obligations expected to be paid out of current assets within one year or the operating cycle, if longer 11 CURRENT LIABILITIES Accounts payable are created when a company buys merchandise or supplies on credit Accrued liabilities represent expenses incurred, but not yet paid 12

5 13 CURRENT LIABILITIES Short-term loans payable are formal, interest-bearing loans expected to be paid within one year The current portion of long-term debt is the portion of these liabilities expected to be paid within one year of the balance sheet date CURRENT LIABILITIES Unearned revenue is the obligation to provide services to customers who have paid in advance 14 LONG-TERM LIABILITIES Long-term liabilities are obligations not expected to be paid or otherwise satisfied within one year 15

6 16 LONG-TERM LIABILITIES Long-term debt includes long-term notes, bonds, and mortgages Capital lease obligations represent leases of plant assets which are equivalent to debt-financed purchases STOCKHOLDERS EQUITY Is the residual interest in a corporation The owners paid-in capital can take the form of common stock or preferred stock 17 STOCKHOLDERS EQUITY Common stockholders Have the most risk Have the potential to reap the greatest return Common stock amounts are reported at Par value (the amount printed on the certificates) Additional paid-in capital (the amount paid above par) 18

7 19 STOCKHOLDERS EQUITY Preferred stockholders Usually have a fixed return on their investment Have fewer ownership rights than common stockholders Have lower risk than common stockholders STOCKHOLDERS EQUITY Retained earnings is the cumulative amount of income that has not been distributed to stockholders as dividends Retained earnings are increased by net income and decreased by net losses and dividends 20 FORM OF THE BALANCE SHEET Side-by-side form Assets are on the left-hand side Liabilities and owners equity are on the right-hand side Columnar form Assets, liabilities, and owners equity are presented vertically 21

8 22 RECOGNITION Recognition means that an amount is recorded and reported in the financial statements As an alternative, disclosure conveys financial information in the form of narrative notes RECOGNITION Recognition is the preferred method of financial reporting when it is appropriate An asset or liability is recognized only if it meets the definition of an asset or liability 23 ASSET: Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events BALANCE SHEET LIABILITY: Probable future sacrifice of economic benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events EQUITY: Residual interest in the assets of an entity that remains after deducting its 24 liabilities

9 25 VALUATION Valuation is the process of assigning a value to an item in the financial statements once it is determined it should be recognized The value should be Relevant (It makes a difference in a user s decision) Reliable (Independent parties can agree on the value) VALUATION Historical cost is an extremely reliable number Market value is an extremely relevant number The balance sheet reflects a mixture of different valuation methods Market value is used when it is both relevant and reliable, e.g., investment securities 26

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