Chapter 2 - The Balance Sheet

Question 0

The Balance Sheet presents the basic equation of accounting in a slightly different way. Explain?

Answer 0

Assets = Liabilities + Worth

*It must always be in balance with assets equaling the sum of liabilities and worth. So, if you add to the left side, you must also add to the right side. Two entries are required to keep the equation in balance.

Question 1

The Basic Equation for Accounting

Answer 1

Assets - Liabilities = Worth

• Worth, Net Worth, Equity, Owner’s Equity and Shareholders’ Equity all mean the same thing.

Question 2

Balance Sheet

Answer 2

Indicates the financial picture of the enterprise on one particular day, an instant in time, the date it was written.

Question 3

What does the balance sheet present?

Answer 3

What the enterprise has today: Assets
How much the enterprise owes today: Liabilities
What the enterprise is worth today: Equity

Has Today = Owes Today + Worth Today

Question 4

What are assets?

Answer 4

Everything you got: Cash in the bank, inventory, machines, buildings - all of it. Also certain “rights” you own that have a monetary value…i.e.: collecting cash from someone who owes you money.

• Assets are valuable and this value must be QUANTIFIABLE for an an asset to be listed on the Balance Sheet. Everything in a company’s financial statements must be translated into dollars and cents.

Question 5

Accounts Receivable

Answer 5

The obligation of customers to pay the company for goods shipped to them on credit.

Question 6

Assets are grouped for presentation on the balance sheet according to what 3 characteristics?

Answer 6

Very Liquid Assets… cash and securities
Productive Assets… plant and machinery
Assets for sale… inventory

Question 7

Current Assets

Answer 7

Those assets that are expected to be converted into cash in less than 12 months.

Question 8

Current Assets: Inventory?

Answer 8

Is both finished products for ready sale to customers and also materials to be made into products.

Question 9

A manufacturer’s inventory includes three groupings. What are they?

Answer 9

Raw Material Inventory: is unprocessed materials that will be used in manufacturing products.

Work-in-process: inventory is partially finished products in the process of being manufactured.

Finished goods inventory: is completed products ready for shipment to customers when they place orders.
* As finished goods inventory is sold it becomes an accounts receivable and then cash when the customer pays.

Question 10

Fixed Assets

Answer 10

Are productive assets not intended for sale. They will be used over and over again to manufacture the product, display it, warehouse it, transport it and so forth.

Commonly include land, buildings, machinery, equipment, furniture, automobiles, trucks, etc.

Question 11

Current Assets: Prepaid Expenses

Answer 11

Bills the company has already paid… but for services not yet received…I.e.: Prepaid insurance premium, prepayment of rent, deposits paid to the telephone company, salary advances, etc.
The are current assets not because they can be turned into cash, but because the enterprise will not have to use cash to pay them in the near future. They have been paid already.

Question 12

Current Asset Cycle or “working cycle”

Answer 12

• -> Cash buys inventory
  
  • –> Inventory when sold becomes accounts receivable
    - –> Accounts receivable upon collection becomes cash

Question 13

When grouping assets for presentation, what are considered the most liquid asset?

Answer 13

Cash
Account Receivable
Inventory
Prepaid Expenses
Which is considered "Current Assets"

Question 14

When grouping assets for presentation, what are considered the least liquid asset?

Answer 14

Fixed Assets at cost
Accumulated Depreciation
Which is considered “Net Fixed Assets”

Question 15

By definition, Current assets are…?

Answer 15

Those assets that are expected to be converted into cash in less than 12 months.

Question 16

Current Asset groupings are listed in order of liquidity with the most easy to convert into cash listed first:

Answer 16

1. Cash
2. Accounts Receivable
3. Inventory

Question 17

Fixed Assets are normally reported on the balance sheet as?

Answer 17

Net Fixed Assets - valued at original cost minus an allowance for depreciation.

Question 18

Depreciation

Answer 18

An accounting convention reporting (on the income statement) the decline in useful value of a fixed asset due to wear and tear from use and the passage of time.

Question 19

Accumulated Depreciation

Answer 19

Is the sum of all the depreciation charges taken since the asset was first acquired.

Question 20

Depreciation charges taken in a period dies what? and Why?

Answer 20

Lower profits for the period, but do not lower cash.

Why…. Because cash was required to purchase the fixed asset originally.

Question 21

What is the formula Net Fixed Assets formula of a company?

Answer 21

The sum of it purchased prices (“fixed assets @ cost”) MINUS the depreciation charges taken on the Income Statement over the years (“accumulated depreciation”)

Question 22

What the Other Assets Category entail on the balance sheet?

Answer 22

Includes assets of the enterprise that cannot be properly classified into current asset or fixed asset categories.

I.e.: Intangible Assets ( a major type of other assets)

Question 23

Intangible Assets

Answer 23

Are things owned by the company that have value but are not tangible in nature.

I.e.: a patent, copyright, etc.

Question 24

What is Liabilities?

Answer 24

Economic obligations of the enterprise such as money that the corporation owes to lenders, suppliers, employees, etc.

Question 25

Liabilities are categorized and grouped for presentation on the balance sheet by:

Answer 25

1. to whom the debt is owed;

2. whether the debt is payable within the year (current liabilities) or is a long-term obligation.

Question 26

Shareholders’ Equity is a very special kind of liability that represents…

Answer 26

The value of the corporation that belongs to its owners

Question 27

Current Liabilities

Answer 27

Are bills that must be paid within one year of the date of the Balance Sheet.

**Current liabilities are a reverse of current assets**

Question 28

Current Liabilities are grouped depending on to whom the debt is owed:

Answer 28

1. Accounts payable owed to suppliers
2. Accrued expenses owed to employees and others for services
3. Current debt owed to lenders
4. Taxes owed to the government

Question 29

Current Liabilities: Accounts Payable

Answer 29

Bills, that are generally to other companies for material and equipment bought on credit, that the corporation must pay soon.

Business-to-Business transactions are most often done on credit. Common trade payment terms are usually 30 to 60 days with a discount for early payment like 2% off if paid within 10 days.

Question 30

Current Liabilities: Accrued Expenses

Answer 30

Monetary obligations similar to account payable.

I.e.: are salaries earned by employees but not yet paid to them; lawyers bills not yet paid; interest due but no yet paid on bank debt and so forth.

Question 31

Current Debt and Long Term Debt

Answer 31

Any notes payable and the current portion of long-term debt are both components of current liabilities and are listed on the balance sheet as Current portion of debt.

Question 32

Current Liabilities: Taxes Payable

Answer 32

Every time the company sells something and makes a profit on the sale, a percentage of the profit will be owed the government as income taxes.

Question 33

What is Income Tax Payable?

Answer 33

Income taxes that the company owes the government but that the company has not yet paid.

• Every three months or so the company will send the government a check for the income taxes owed.

Question 34

Working Capital

Answer 34

The amount of money left over after you subtract current liabilities from current assets.

Question 35

Working Capital Formula

Answer 35

Current Assets - Current Liabilities = Working Capital
Cash Accounts Payable
Accounts Receivable Accrued Expenses
Inventory Current Debt
Prepaid Expenses Taxes Payable

Question 36

What is a company’s Total Liabilities?

Answer 36

The sum of its current liabilities and its long-term debt.

Question 37

Long-term Debt

Answer 37

Any loan to the company to be prepaid more than 12 months after the date of the balance sheet.

*Common types of long-term debt include mortgages for land and buildings and so-called chattel mortgages for machinery and equipment.

Question 38

Shareholders’ Equity

Answer 38

Subtract what the company owes from what it has you are left with companies value to its owners… its shareholders’ equity.

Total Assets - Total Liabilities = Shareholders’ Equity

Question 39

Shareholders’ Equity has two components:

Answer 39

1. Capital Stock: The original amount of money the owners contributed as their investment in the stock of the company.
2. Retained Earnings: All the earnings of the company that have retained, that is, not paid out as dividends to owners.

*** Both “net worth” and “book value” means the same thing as shareholders’ equity.

Question 40

Capital Stock

Answer 40

The original money to start and any add-on money invested in the business is represented by shares held by owners of the enterprise.

Question 41

Common Stock

Answer 41

Is the regular “denomination of ownership” for all corporations.

Question 42

Preferred Stock

Answer 42

Companies often issue preferred stock that have certain contractual rights or “preferences” over the common stock.

Question 43

The value of shareholders’ equity INCREASES when the company…?

Answer 43

1. Makes a profit, thereby increasing retained earnings, or

2. Sells new stock to investors, thereby increasing capital stock.

Question 44

The value of shareholders’ equity DECREASES when the company…?

Answer 44

1. Has a loss, thereby lowering retained earnings, or

2. Pays dividends to shareholders, thereby lowering retained earnings.

Question 45

Retained Earnings Formula

Answer 45

Retained earnings = sum of all profits - sum of all dividends

Question 46

Retained Earnings

Answer 46

All the earnings of the company that have retained, that is, not paid out as dividends to owners.

Question 47

Negative Retained Earnings

Answer 47

If the company has not made a profit but rather has sustained losses it has “negative retained earnings” that are called accumulated deficit.

Question 48

Current Debt and Long Term Debt

Answer 48

The so-called “current portion of long-term debt” is that amount due for payment within 12 months and is a current liability listed under current portion of debt.