- Describe the purpose and three main elements of a balance sheet.
- Classify assets, liabilities, and stockholders’ equity accounts into their proper sections.
- Apply contra accounts when calculating reported balances.
- Prepare a classified balance sheet and determine retained earnings from the accounting equation.
Understanding the Balance Sheet
A balance sheet presents an entity’s financial position on one specific date.
A balance sheet reports a business’s assets, liabilities, and shareholders’ equity at a particular point in time. It is a one-day snapshot of the resources the business owns or controls, the obligations it owes, and the owners’ interest. For this reason, it is also known as the statement of financial position.
The statement balances because the owners’ residual interest equals assets after liabilities are deducted. Knowing two parts of the equation allows the third to be calculated.
A company reports USD 500,000 of assets and USD 300,000 of liabilities. What is its equity?
USD 200,000, calculated as USD 500,000 − USD 300,000.
Classifying Assets
Assets are grouped by liquidity and by their role in the business.
- Current assets: cash and other resources expected to be converted to cash, sold, or consumed within one year or the operating cycle, whichever is longer.
- Long-term investments: securities, investment land, special funds, and interests in nonconsolidated subsidiaries held beyond the current period.
- Property, plant, and equipment: tangible, long-lived resources used in normal operations, including land, buildings, machinery, and equipment.
- Intangible assets: nonfinancial assets without physical substance, such as goodwill, franchises, patents, and trademarks.
- Other assets: unusual resources that do not belong in the preceding groups, including prepaid pension costs and deferred income tax assets.
Current Assets
| Item | Meaning or treatment |
|---|---|
| Cash and cash equivalents | On-demand money and highly liquid investments maturing within three months or less; reported at fair value. Restrictions or commitments are disclosed. |
| Short-term investments | Debt and equity securities, generally measured at fair value and assigned to one of three portfolios. |
| Receivables | Reported at the estimated collectible amount. The anticipated uncollectible loss, significant nontrade receivables, and receivables pledged as collateral must be identified. |
| Inventories | Reported at the lower of cost or market, with the valuation basis and cost-flow assumption, such as FIFO or LIFO, disclosed. |
| Prepaid expenses | Cash paid for a service or benefit to be received later; initially recorded as an asset at cost. |
| Portfolio | Description and classification |
|---|---|
| Held-to-maturity | Debt securities the company positively intends and is able to retain until maturity; may be current or noncurrent. |
| Trading | Debt and equity securities held for near-term sale to earn from short-term price movements; classified as current. |
| Available-for-sale | Debt and equity securities outside the other two portfolios; may be current or noncurrent. |
Long-Term Investments
- Bonds, common stock, and long-term notes
- Tangible assets not used in operations, such as land retained for speculation
- Special funds, including sinking, pension, plant-expansion, and life-insurance cash-surrender-value funds
- Nonconsolidated subsidiaries and affiliated entities
Property, Plant, and Equipment
Property, plant, and equipment consists of physical, long-lived assets used in regular operations. Examples include land, buildings, machinery, furniture, tools, and wasting resources such as minerals. Buildings and similar assets are depreciated; natural resources such as oil reserves are depleted. Land is the exception because it is not depreciated.
Intangible and Other Assets
Intangible assets have no physical substance and are not financial instruments. Limited-life intangibles are amortized. Indefinite-life intangibles are tested for impairment.
Classifying Liabilities
Liabilities are separated according to when and how the company expects to settle them.
- Accounts Payable: amounts owed to suppliers
- Short-term Notes Payable: notes due within one year
- Salaries and Wages Payable: employee compensation earned but unpaid
- Interest Payable: interest that has accrued
- Income Taxes Payable: taxes owed to the government
- Unearned Revenue: cash collected before the related service is performed
- Dividends Payable: dividends declared but not yet paid
Current-Liability Example
Long-Term Liabilities
Long-term liabilities are obligations not expected to be settled during the normal operating cycle. Bonds payable, long-term notes, and pension liabilities are examples. Related covenants and restrictions must be disclosed.
Owners’ Equity
A corporation commonly presents its equity in six components.
- Capital Stock: the par or stated value of issued shares.
- Additional Paid-in Capital: investor contributions above the shares’ par or stated value.
- Retained Earnings: accumulated corporate earnings not distributed to owners.
- Accumulated Other Comprehensive Income or Loss: the combined amount of other comprehensive income items.
- Treasury Stock: the amount associated with shares repurchased by the corporation; it reduces equity.
- Noncontrolling Interest: the equity in subsidiaries not wholly owned by the reporting company.
Preparing a Complete Balance Sheet
The Scott Butler Corporation example brings the classifications and calculations together.
Scott Butler Corporation’s December 31, 2014 trial balance is used to prepare a balance sheet, ignoring income taxes. Income-statement accounts, including Sales Revenue of USD 8,100,000, are excluded. The USD 78,000 shown beside Retained Earnings is not the actual balance, so retained earnings must be derived after the other totals are known.
| Account | Balance / Balance-sheet classification |
|---|---|
| Cash | Balance:USD 197,000 debitBalance-sheet classification:Current asset |
| Debt Investments (Trading), cost USD 145,000 | Balance:USD 153,000 debitBalance-sheet classification:Current asset at the account’s fair-value balance |
| Debt Investments (long-term) | Balance:USD 299,000 debitBalance-sheet classification:Long-term investment |
| Equity Investments (long-term) | Balance:USD 277,000 debitBalance-sheet classification:Long-term investment |
| Accounts Receivable | Balance:USD 435,000 debitBalance-sheet classification:Current asset |
| Allowance for Doubtful Accounts | Balance:USD 25,000 creditBalance-sheet classification:Contra-current asset |
| Inventory | Balance:USD 597,000 debitBalance-sheet classification:Current asset |
| Land | Balance:USD 260,000 debitBalance-sheet classification:Property, plant, and equipment |
| Buildings | Balance:USD 1,040,000 debitBalance-sheet classification:Property, plant, and equipment |
| Accumulated Depreciation—Buildings | Balance:USD 152,000 creditBalance-sheet classification:Contra-PP&E |
| Equipment | Balance:USD 600,000 debitBalance-sheet classification:Property, plant, and equipment |
| Accumulated Depreciation—Equipment | Balance:USD 60,000 creditBalance-sheet classification:Contra-PP&E |
| Franchises | Balance:USD 160,000 debitBalance-sheet classification:Intangible asset |
| Patents | Balance:USD 195,000 debitBalance-sheet classification:Intangible asset |
| Notes Payable (short-term) | Balance:USD 90,000 creditBalance-sheet classification:Current liability |
| Accounts Payable | Balance:USD 455,000 creditBalance-sheet classification:Current liability |
| Dividends Payable | Balance:USD 136,000 creditBalance-sheet classification:Current liability |
| Accrued Liabilities | Balance:USD 96,000 creditBalance-sheet classification:Current liability |
| Notes Payable (long-term) | Balance:USD 900,000 creditBalance-sheet classification:Long-term liability |
| Bonds Payable | Balance:USD 1,000,000 creditBalance-sheet classification:Long-term liability |
| Common Stock (USD 5 par) | Balance:USD 1,000,000 creditBalance-sheet classification:Paid-in capital |
| Paid-in Capital in Excess of Par | Balance:USD 80,000 creditBalance-sheet classification:Additional paid-in capital |
| Treasury Stock | Balance:USD 191,000 debitBalance-sheet classification:Contra-equity |
| Retained Earnings | Balance:USD 78,000 shown, but not the actual balanceBalance-sheet classification:Must be calculated |
Steps 1–5: Calculate Assets
| Section | Calculation / Total |
|---|---|
| Current assets | Calculation:USD 197,000 + USD 153,000 + USD 435,000 − USD 25,000 + USD 597,000Total:USD 1,357,000 |
| Long-term investments | Calculation:USD 299,000 + USD 277,000Total:USD 576,000 |
| Property, plant, and equipment | Calculation:USD 260,000 + USD 1,040,000 + USD 600,000 − USD 152,000 − USD 60,000Total:USD 1,688,000 |
| Intangible assets | Calculation:USD 160,000 + USD 195,000Total:USD 355,000 |
Steps 6–8: Calculate Liabilities
| Section | Calculation / Total |
|---|---|
| Current liabilities | Calculation:USD 90,000 + USD 455,000 + USD 136,000 + USD 96,000Total:USD 777,000 |
| Long-term liabilities | Calculation:USD 900,000 + USD 1,000,000Total:USD 1,900,000 |
Step 9: Determine Equity and Retained Earnings
Step 10: Present the Statement
SCOTT BUTLER CORPORATION
Balance Sheet
December 31, 2014
ASSETS
Current Assets
Cash $197,000
Debt Investments (Trading) 153,000
Accounts Receivable $435,000
Less: Allowance for Doubtful Accounts (25,000) 410,000
Inventory 597,000
Total Current Assets $1,357,000
Long-term Investments
Debt Investments (long-term) $299,000
Equity Investments (long-term) 277,000
Total Long-term Investments 576,000
Property, Plant, and Equipment
Land $260,000
Buildings 1,040,000
Equipment 600,000
Less: Accumulated Depreciation—Buildings (152,000)
Less: Accumulated Depreciation—Equipment (60,000)
Total Property, Plant, and Equipment 1,688,000
Intangible Assets
Franchises $160,000
Patents 195,000
Total Intangible Assets 355,000
Total Assets $3,976,000
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Notes Payable (short-term) $90,000
Accounts Payable 455,000
Dividends Payable 136,000
Accrued Liabilities 96,000
Total Current Liabilities $777,000
Long-term Liabilities
Notes Payable (long-term) $900,000
Bonds Payable 1,000,000
Total Long-term Liabilities 1,900,000
Total Liabilities 2,677,000
Stockholders’ Equity
Common Stock ($5 par) $1,000,000
Paid-in Capital in Excess of Par 80,000
Retained Earnings 410,000
Less: Treasury Stock (191,000)
Total Stockholders’ Equity 1,299,000
Total Liabilities and Stockholders’ Equity $3,976,000What confirms that the completed Scott Butler Corporation balance sheet is in balance?
Total assets and total liabilities plus stockholders’ equity both equal USD 3,976,000.
Common misconceptions
Watch out: Contra accounts should be added to the accounts they accompany.
Instead: A contra account reduces its related balance. The examples deduct the doubtful-accounts allowance from receivables, accumulated depreciation from PP&E, the bond discount from Bonds Payable, and Treasury Stock from equity.
Watch out: Every parcel of land belongs in property, plant, and equipment.
Instead: Land used in operations is PP&E, while land held for investment belongs in long-term investments.
Watch out: Every tangible long-lived asset is depreciated.
Instead: Buildings and similar assets are depreciated, natural resources are depleted, and land is not depreciated.
Watch out: Prepaid Rent belongs with intangible assets because it provides a future benefit.
Instead: The lesson classifies Prepaid Rent as a current asset; it is not an intangible asset.
Watch out: Bonds Payable should be included with current liabilities.
Instead: In the examples, bonds due beyond the current period are classified as long-term liabilities.
Lesson recap
- A balance sheet shows assets, liabilities, and equity on a single date.
- The governing relationship is Assets = Liabilities + Equity.
- Assets are organized as current assets, long-term investments, property, plant, and equipment, intangible assets, and other assets.
- Liabilities are separated into current and long-term obligations.
- Corporate equity may contain capital stock, additional paid-in capital, retained earnings, accumulated other comprehensive income or loss, Treasury Stock, and noncontrolling interest.
- Contra accounts reduce the balances of the related assets, liabilities, or equity accounts.
- Correct classification and totals reveal the company’s liquidity, solvency, financial position, and sources of operating finance.