part 1 - basic concepts Flashcards
balance sheet
snapshot of the financial position of an entity at one moment in time
total paid-in capital
total funds supplied by equity investors; includes common stock
equity
equity on balance sheet is equal to common stock plus additional paid-in capital (together, total paid-in capital) plus retained earnings
dual-aspect concept
states that assets always equal sum of liabilities and equity
in the case that liabilities > assets, this equality still holds; in this case, equity is negative
net assets
same thing as equity (assets - liabilities)
this term is more typical for non-profits
money measurement concept
in accounting, every item is given a dollar value so you can add and subtract them; if we didn’t have this, we would be forced to add apples to oranges
if something cannot be quantified in terms of money, it is not possible to include it in balance sheet - examples:
health of company ceo
potential of employees striking
because accounting reports only include facts about a company that involve its finances, they are not complete by definition; there are other things that affect a company that cannot be known from financial statements.
entity concept
accounts are kept for an entity (business) that are separate from the financials of the person who owns that entity
several types - corporation, partnership, proprietorship, etc.
going-concern concept
assumption that an entity will persist from one year into the next
asset-measurement concept
states that if reliable information is available, an asset will be measured at its fair value
reliable information includes stock prices, the value of cash because it’s easily ascertained, etc.
for assets like land that are purchased, they are recorded at the amount of their cost at purchase; this may not reflect the fair value today (example: land purchased ten years ago is probably worth more now, but it is recorded at the amount that it cost the company ten years ago)
in general, land, buildings, equipment and inventory have subjective values and cannot be measured reliably except at the time they are acquired; therefore, they are reported at cost which is an objective metric; in the case of buildings and equipment, they are reported at a number less than cost because they are depreciated over time
it is okay to not measure fair value of assets like land and equipment; assets like these will be used continuously while the entity is a going concern; therefore, they will be used up and calculating fair value is both difficult and unnecessary
in summary, according to asset-management concept, if reliable info. is available, asset is measured at its fair value; if not, it’s measured at cost (and depreciated in the case of buildings and equipment)
monetary assets are measured at fair value; they incl. cash, bonds and other securities
non-monetary assets are measured at cost or some number related to their cost; they incl. land, equipment, buildings and inventory
this should make it obvious that accounting cannot really tell you what a company is actually worth (since many of the assets will not be priced at fair value in the financial statements)
to be considered an asset, an item must meet these three criteria
1 - it must be controlled by the entity (meaning controlled by the company whose financial statements you are looking at)
2 - it must be valuable to the entity; any item that is non-functioning is no longer valuable and is thus not an asset
3 - it must have been acquired at a measurable cost; by this logic, a company’s good reputation - while valuable - is not an asset; exception to this is when goodwill is purchased in a business transaction because this has a measurable cost
current vs. non-current assets
current assets are ones expected to be converted into cash or used up in near future (usually within one year)
non-current assets are those expected to be useful for longer than a year
current liabilities
claims that become due within a short period, usually one year
current ratio
current assets : current liabilities
indicates company’s ability to meet its current obligations
equity
capital obtained from sources that are not liabilities
includes paid-in capital and retained earnings
paid-in capital = capital supplied by equity investors; this includes common stock and other forms (which are referred to as additional paid-in capital)
retained earnings = the amount of equity earned through profitable operations of the company and retained by the entity (what’s left after dividends are paid out); the amount listed in the balance sheet is cumulative - meaning since the entity started, not for a single year; retained earnings are not cash; cash is an asset; retained earnings are capital generated from operating activities
side note = for publicly-traded companies, although the stock price changes continuously, this has no bearing on the company’s balance sheet; transactions between individual shareholders do not affect the entity (i.e. the entity concept applies)
explanation of
assets = liabilities + equity
can be interpreted in two ways
1 - liabilities + equity are claims against assets of the entity
2 - liabilities + equity are the sources the entity used to acquire its assets (its sources of capital); liabilities are sourced from creditors; equity is sourced from investors or generated via profitable operations (recorded as retanied earnings)
