CHAPTER 2 THE BALANCE SHEET

PROPERTY AND EQUIPMENT

Consists of fixed assets including land, buildings, furnishings and equipment, construction in progress, and leasehold improvements as well as property and equipment under capital leases. With the exception of land, the cost of all property and equipment is written off to expense - depreciation - over time in accordance with the matching principle. Depreciation methods used should be disclosed in a footnote to the balance sheet.

INVESTMENT S

Generally includes debt or equity securities and ownership interests that are expected to be held on a long-term basis. In marketable equity securities and debt securities are treated differently based on whether there is the intent and ability to hold such securities to maturity or not.

FOOTNOTES

THE FULL DISCLOSURE PRINCIPLE REQUIRES THAT FINANCIAL INFORMATION BE SUFFICIENT TO INFORM CREDITORS, OWNERS, AND OTHER USERS. THIS CAN ONLY BE ACCOMPLISHED BY PROVIDING FOOTNOTES TO THE FINANCIAL STATEMENTS. SHOULD CONTAIN INFORMATION NOT PRESENTED IN THE FINANCIAL STATEMENTS THAT PROVIDES CONTEXTUAL INFORMATION NEEDED TO INTERPRET THOSE STATEMENTS. SHOULD NOT CONTRADICT OR SOFTEN THE DISCLOSURE OF THE FINANCIAL STATEMENTS, BUT RATHER PROVIDE NEEDED EXPLANATIONS.

THE UNIQUE TRAIT OF THE BALANCE SHEET

The income statement, the statement of owners' equity, and the statement of cash flows all pertain to a period of time. The balance sheet reflects an operation's financial position—its assets, liabilities, and owners' equity —at a given date. The balance sheet reflects, or tests and proves, the fundamental accounting equation-assets equal liabilities plus owners' equity.

MAJOR ELEMENTS OF THE BALANCE SHEET

Assets; Liabilities; Owners' equity.

LIMITATION #3: STATIC NATURE

BALANCE SHEETS REFLECT A PROPERTY'S FINANCIAL POSITION ONLY AT A SINGLE MOMENT IN TIME. • THEY BECOME LESS USEFUL AS THEY BECOME OUTDATED. • THE FINANCIAL POSITION REFLECTED AT YEAR-END MAY BE QUITE DIFFERENT ONE MONTH LATER. • THIS IS PARTICULARLY TRUE IF AN OPERATION MAKES A MAJOR INVESTMENT IN FIXED ASSETS.

OTHER ASSETS

CONSISTS OF ALL NON-CURRENT ASSETS NOT INCLUDED IN PREVIOUS CATEGORIES. OTHER ASSETS INCLUDE: INTANGIBLE ASSETS; CASH SURRENDER VALUE OF LIFE INSURANCE; DEFERRED CHARGES; DEFERRED INCOME TAXES— NON-CURRENT • OPERATING EQUIPMENT; RESTRICTED CASH.

TYPICAL COMPONENTS OF CURRENT ASSETS

Cash; Marketable securities; Receivables; Inventories; Amounts due from owner, management company, or related party; Prepaid expenses.

Liabilities

Current and long term.

CURRENT ACCOUNTS

Current assets and Current liabilities; A normal operating cycle may be a few days or several months long. The hospitality industry commonly classifies assets as current/non-current on the basis of one year rather than the normal operating cycle.

Assets

Current assets, non-current receivables, investments, property and equipment -fixed-, and other assets.

THE ACCOUNT FORMAT

LISTS THE ASSET ACCOUNTS ON THE LEFT SIDE OF THE PAGE AND THE LIABILITY AND OWNERS' EQUITY ACCOUNTS ON THE RIGHT SIDE.

LIQUIDITY

Measures an operation's ability to convert assets to cash. Profit alone does not guarantee that a business will be able to meet its financial obligations as they become due. Ideally, a business will have sufficient liquidity both to pay its bills and to provide its owners with adequate dividends.

TYPICAL COMPONENTS OF CURRENT LIABILITIES

Notes payable; Accounts payable; Accrued expenses; Advance deposits; Income taxes payable; Deferred income taxes. Amounts due to owner, management company, or related party. Current maturities of long-term debt.

Current assets

Refers to items to be converted to cash or used in operations within one year or a normal operating cycle.

THE REPORT FORMAT

SHOWS ASSETS FOLLOWED BY LIABILITIES AND OWNERS' EQUITY. THE GROUP TOTALS ON THE REPORT FORM CAN SHOW EITHER THAT ASSETS EQUAL LIABILITIES AND OWNERS' EQUITY OR THAT ASSETS MINUS LIABILITIES EQUAL OWNERS' EQUITY.

LIMITATIONS OF THE BALANCE SHEET

1. VALUATIONS OF ASSETS ARE NOT CURRENT VALUES. 2. NOT ALL ASSETS APPEAR ON BALANCE SHEETS. 3. THE BALANCE SHEET IS STATIC IN NATURE. 4. SOME VALUATIONS ARE INEXACT.

VERTICAL ANALYSIS

ALSO KNOWN AS COMMON-SIZE STATEMENT ANALYSIS, REDUCES FIGURES TO PERCENTAGES. INDIVIDUAL ASSET ARE STATED AS PERCENTAGES OF TOTAL ASSETS. LIABILITY AND EQUITY ACCOUNTS ARE EXPRESSED AS PERCENTAGES OF TOTAL LIABILITIES AND OWNERS' EQUITY. COMMON-SIZE BALANCE SHEETS PERMIT A COMPARISON OF AMOUNTS RELATIVE TO A BASE WITHIN EACH PERIOD. COMMON-SIZE STATEMENT COMPARISONS MAY ALSO BE MADE AGAINST OTHER OPERATIONS' FINANCIAL STATEMENTS AND AGAINST INDUSTRY AVERAGES. COMMON-SIZE FIGURES ALSO ARE HELPFUL IN COMPARING OPERATIONS OF DIFFERENT SIZES.

BASE-YEAR COMPARISONS

ANOTHER APPROACH TO ANALYZING BALANCE SHEETS. THIS APPROACH ALLOWS A MEANINGFUL COMPARISON OF THE BALANCE SHEETS FOR SEVERAL PERIODS. A BASE PERIOD IS SELECTED AS A STARTING POINT, AND ALL SUBSEQUENT PERIODS ARE COMPARED WITH THE BASE. MAKE IT EASY TO QUICKLY DETERMINE THE CHANGES OVER A PERIOD OF TIME.

LIMITATION #2: OMISSION S

Balance sheets fail to reflect many elements of value to hospitality operations. The people providing the services are critical to hotels, motels, restaurants, clubs, and other hospitality sectors, but the balance sheet does not reflect the human resource investment. Millions of dollars are spent in recruiting and training to achieve an efficient and highly motivated work force, yet this essential element is not shown as an asset.

LONG-TERM LIABILITIES

Are obligations at the balance sheet date that are expected to be paid beyond the next 12 months. Common long-term liabilities include notes payable, mortgages payable, bonds payable, capitalized lease obligations, and deferred income taxes. Any long-term debt to be paid with current assets within the next year is reclassified as current liabilities.

Current liabilities

Are obligations that are expected to be satisfied either by using current assets or by creating other current liabilities within one year or a normal operating cycle.

THE CURRENT RATIO

CURRENT ASSETS DIVIDED BY CURRENT LIABILITIES. MANY LONG-TERM LOANS SPECIFY A REQUIRED CURRENT RATIO; FAILURE TO MEET THE REQUIREMENT MAY RESULT IN ALL LONG-TERM DEBT BECOMING DUE IMMEDIATELY. SINCE FEW OPERATIONS COULD RAISE LARGE SUMS OF CASH QUICKLY, BANKRUPTCY COULD RESULT. THEREFORE, MANAGEMENT MUST CAREFULLY MONITOR THE BALANCE SHEET TO ENSURE THAT THE OPERATION IS IN COMPLIANCE.

HORIZONTAL ANALYSIS

Compares two balance sheets— the current balance sheet and the balance sheet of the previous period. The two balance sheets are often referred to as comparative balance sheets. Is the simplest approach to analysis and is essential to fairly reporting financial information. This approach often expresses the changes from one period to the next in both absolute and relative terms.

NON-CURRENT RECEIVABLES

INCLUDES BOTH ACCOUNTS AND NOTES RECEIVABLE THAT ARE NOT EXPECTED TO BE COLLECTED WITHIN ONE YEAR FROM THE BALANCE SHEET DATE. IF ANY COLLECTABILITY IS UNCERTAIN REGARDING NON-CURRENT RECEIVABLES, AN ALLOWANCE FOR DOUBTFUL NON-CURRENT RECEIVABLES SHOULD BE USED. THE ALLOWANCE FOR DOUBTFUL NON-CURRENT RECEIVABLES IS SUBTRACTED FROM TOTAL NON-CURRENT RECEIVABLES TO PROVIDE NET NON-CURRENT RECEIVABLES.

INVESTMENT S continue

In affiliated entities should be shown separately, unless insignificant. In property for future development generally should also be accounted for as investments. The accounting method and valuation basis should be disclosed in notes to the financial statements.

LIMITATION #4: INEXACTNESS

SEVERAL BALANCE SHEET ITEMS ARE BASED ON ESTIMATES: • ACCOUNTS RECEIVABLE—NET -ESTIMATE OF COLLECTIBLE PORTION. • INVENTORY -LOWER OF COST OR MARKET. • PROPERTY AND EQUIPMENT -COST LESS ESTIMATED DEPRECIATION. IN EACH CASE, WHEN THE ESTIMATES ARE IN ERROR, THE BALANCE SHEET ITEMS WILL BE WRONG.

LIMITATION #1: VALUATION S

Since the balance sheet is based on the cost principle, it often does not reflect current values of some assets, such as property and equipment. This difference may be significant. Since real estate prices can fluctuate wildly, the value of property is particularly vulnerable to inaccurate valuations. A misstatement of the value of a property's assets could lead to less than optimal use of those assets.

BALANCE SHEET FORMATS

THE BALANCE SHEET CAN BE ARRANGED IN EITHER THE ACCOUNT OR REPORT FORMAT.

BALANCE SHEET ANALYSIS

The analysis of a balance sheet may include the following: Horizontal analysis - comparative statements; Vertical analysis - common-size statements; Base-year comparisons; Ratio analysis.

OWNERS' EQUITY

The detail of the owners' equity section depends on the operation's business form. For a corporation, this section includes capital stock - common and, when issued, preferred, additional paid-in capital, retained earnings, and treasury stock. For a sole proprietorship, partnership, or LLC, equity is listed by owner, partners, or members, respectively.