Accounting for Lawyers - Balance Sheet (financial statements)
Classifications of current Assets:
(1) cash and cash equivalents (2) short-term investments (3) Accounts Receivable (4) Inventory (5) Prepaid Expenses (6) Other Current Assets
possible uses of retained earnings:
(1) dividends (2) stock dividends (3) appropriated retained earnings
Contributed Capital:
Capital contributions are increases in equity resulting from asset contributions (or liability reductions) by the owners of the company. Capital contributions relate to the investment of the owners in the company and not to the business of the company.
(1) Cash & Cash Equivalents:
Cash is money presently and immediately available for the operation of the business. It does not include cash or money that has been set aside (or appropriated) for some specific purpose other than for normal operations, such as a "sinking fund" for the retirement of the company's outstanding stocks or bonds. Cash Equivalents include certain items that are readily convertible into cash, such as Treasury Bills, commercial paper, and certificates of deposit.
Order of listing for Assets. First: Current Assets
Current assets are cash and other resources that are expected to be realized in cash when sold or consumed either within one year or within the "normal operating cycle" of the business. The arbitrary one year assumption is used on the assumption that most businesses require one year or less in which to purchase materials, produce a product, sell it, and collect the purchase price. This is the process of going "from cash to cash."
After listing investments, accountants list:
Fixed Assets
After listing Fixed Assets, accountants list:
Intangible Assets
After listing current assets, accountants then list:
Investments
After listing intangible assets, accountants list:
Other Assets
Balance Sheet:
The balance sheet is a statement of the entity's asset, liability, and equity accounts at a point in time. (SNAPSHOT)
The Cost Principle
Under the cost principle, assets are initially recorded at their cost. In cash transactions, cost is equal to the amount of money a company pays for the asset. In non cash transactions, cost is equal to the value of the asset received or the value of the asset given, whichever is more readily ascertainable.
Bonds
bonds are like promissory notes. A bond evidences a promise to pay a definite sum of money to its holder at a fixed future date. Like notes, bonds obligate the corporation that issues them to pay interest to the bondholder. accountants record the principal portion of bonds in the long term liabilities section of the balance sheet. Bond repayments are often secured by specific corporation assets.
additional paid in capital - capital surplus:
capital surplus reflects increases in owners' equity not arising from the company's normal business operations or from the sale of goods. This includes: Donated capital paid in capital revaluation surplus.
types of current assets
cash short-term investment accounts receivable notes receivable inventory (to be sold) supplies prepaid expenses
current assets:
cash, securities, A/R, Inventory, prepaid expenses (can be converted into cash within 12 months.
Current liabilities:
companies list current liabilities first in the liability section of the balance sheet. current liabilities are debts that the company expects to pay either with current assets or by creating current liabilities. all other liabilities are long-term liabilities. Some of the more common current liabilities include: (1) accounts payable (2) Declared dividends payable (3) others.
Depreciation:
companies may depreciate assets whose ability to produce benefits declines over time (so called wasting assets)
Other Assets:
companies may have other assets (or classification of assets) on their balance sheet. These other assets will vary from company to company.
(6) Other current assets:
companies may list other current assets on the balance sheet. For example, they may list items such as accrued interest receivable as a current asset. This is interest that the company has earned but has not yet received.
Stock Dividends:
companies may use retained earnings to pay dividends of additional stock to the shareholders. This amounts to a simple transfer of a portion of the retained earnings account to the capital stock account.
Common stock:
corporations may issue stock to shareholders for par value (an arbitrary value assigned to the stock by the corporations articles of incorporation) or for a stated value set by the board. Par value stock may not be sold for less than par. The balance sheet will include complete information about each class of stock issued
Appropriated retained earnings:
corporations sometimes set apart a portion of retained earnings for some specific purpose. Thus, although it may appear as if not all of the retained earnings are available for dividends, in fact this is legally not the case. This is only a management designation with no legal restraints on the payment of dividends out of these funds.
Corporations:
corporations transact by far, the greatest dollar volume of business. three basis features of the corporation: (1) the corporation is a separate and intangible legal entity. (2) This separate status is the basis for most of the advantages and disadvantages of incorporating. (3) This status gives the corporation most of the rights and responsibilities of a natural person, including the right by itself to enter into K's and trade in property, separate from the corporations shareholders (owners)
Importance of current assets:
current assets frequently command greater attention than other asset classifications because solvency, expansion capability, and the ability to pay dividends to shareholders all depend on the working capital position of the business. working capital is determined by measuring the excess of current assets over current liabilities.
Declared Dividends:
dividends payable are dividends a company has declared but not yet paid. They are classified as current liabilities if the company expects to pay them using current assets.
Partnerships and individual proprietorships
here, owners' equity is shown on the balance sheet simply by indicating the individual's name and the amount of equity to the persons credit at the balance sheet date. a partnership statement is very similar, with each of the partners and their ownership interests listed. FORMAT: the owners' equity section will usually show all the changes in the equity accounts during the past accounting period. The statement then shows the balance at the end of the last period, the accumulations of the period, the withdrawals, and the new balance.
Example of operating cycle
if a business has an inventory turnover of 6 times per year (i.e. its sales during a year equal 6 times the average inventory of the company at any point during the year) and sells on 30 day credit terms (i.e. the business is paid by customers 30 days after the sale is made), the operating cycle of the business would actually be about 90 days (i.e. 12 months divided by 6, or two months, plus 30 days for payment.)
Paid in capital
if stock is sold for more than its par or stated value, this surplus is "paid in" by the shareholders.
(4) Inventory
inventory is a current asset that appears on the balance sheet. It consists of: (i) goods that are ready for sale (finished goods inventory); (ii) partially completed goods (work in process); and (iii) available materials to be used in the production of goods (materials inventory).
LIABILITIES:
liabilities are all items having probable future sacrifices of benefits. They are all claims on the assets other than the claims of the owners. On the balance sheet, accountants list them in the order in which the company expects to pay them.
Included Items:
line items included in this statement are: the beginning balance net income earned dividends paid and an ending balance. note how this concept parallels the "COGS" format.
types of long term assets:
long term investments equipment buildings land intangibles
Long term liabilities:
long term liabilities are the principal portion of debts that are not current liabilities. i.e. debts the company does not expect to pay using current assets or by creating current liabilities. Examples include bonds payable or mortgages payable.
Statement of Retained Earnings:
most corporations publish a statement of retained earnings to show the reasons for an increase or decrease in the account during the accounting period.
What would increase retained earnings?
net income would increase retained earnings. you close the income statement and have to zero it out at the end of the year, but that is the income statement. the net income on that loss has to end up somewhere and it migrates to the balance sheet in the OE and retained earnings.
Net Earnings:
normally all the accumulated earnings of a business will be included in the retained earnings account. However, losses are subtracted, and if the business loses so much that total losses exceeds gains, the losses are listed in the retained earnings account as a deficit.
Valuation of Assets:
only resources that can be valued in money terms can be listed on balance sheet. Generally, assets will be valued at their cost except for inventories and securities.
Other current liabilities:
other current liabilities include estimated tax liabilities, interest payable, accrued wages payable, and the current principal portion of long term liabilities.
OWNER'S EQUITY
owner's equity is a reflection of the total original investment, plus all accumulated profits, less all withdrawals or losses. The headings used in the owners' equity section of the balance sheet depend on the kind of business involved - i.e. a partnership or corporation.
(5) Prepaid Expenses:
prepaid expenses are usually the next items in the current asset section of the balance sheet. There are payments the company made for services to be rendered in the near future (hence, they are assets because they have probable future benefits). They are akin to inventories of future services to be rendered. Examples: prepaid insurance for multiple accounting periods and prepaid taxes for the next (or multiple) accounting period(s).
Fixed Assets:
property, plant, & equipment.
RETAINED EARNINGS:
retained earnings (or "earned surplus") is the total accumulation of earnings minus dividends paid to shareholders since the date of incorporation.
dividends:
retained earnings may be used in several ways. The most common use is for the payment of dividends to shareholders.
effect of dividends:
retained earnings shows the increase or decrease in the shareholders' equity that has resulted from the operations of the business (minus dividends paid by the corporation), Thus, retained earnings = net profits - dividends. Beginning retained earnings + net income - dividends paid = ending retained earnings.
The term balance sheet means:
that the total assets shown on the statement will be balanced against (or equal to) the total liabilities plus the owners equity.
Balance sheet reflects:
the financial condition of a company at a particular time (usually last day of the calendar fiscal year) continuity of numbers attempts to portray the economic resources and burdens of an entity as a snapshot in time.
Intangible Assets:
the next entry on the balance sheet is intangible assets. intangible assets have 4 characteristics: they lack physical substance, they have probable future economic benefits, their useful life is difficult to determine, and they are generally acquired for operational use. in general, intangible assets are accounted for in the same manner as other operational assets. at acquisition, accountants record them at cost. Accountants amortize (a process like depreciation of fixed assets) this cost over some period. when companies dispose of them, accounts record a gain or loss equal to the difference between the amount received and the asset's book value.
Fixed assets:
this category of assets is also called "property, plant, and equipment" or "operational assets" and includes assets having a physical substance that are used in the operation of the business over a relatively long period of time. this is opposed to inventory which is held for resale. net fixed assets are also called "book value."
donated capital:
this type of capital surplus arises where a gift is made to the corporation.
FMV vs. original cost:
to attain consistency (and maintain a conservative estimate of value) FMV is generally AVOIDED as a measure of value, and assets are normally recorded on the balance sheet at their original cost to the business entity.
(3) Accounts receivable:
trade accounts receivable are amounts due from customers generated in the normal course of business operations. For example, an account receivable from a customer arises from the sale of the entity's inventory or services (without the collection of cash due from that sale). An account receivable is typically not evidenced by a promissory note, but the amount owing is found from from the ledger account balance of each customer and can be a total receivable from numerous sales.
Method of Computing Depreciation: Straight line method
under this method, accountants compute yearly depreciation expense as a total cost of the asset (minus any salvage value) divided by its useful life.
Preferred stock:
usually has a prior claim on dividends
Other Assets:
usually intangible (patents, copyrights, etc.)
Order of Listing:
Accountants normally classify assets into groups such as current assets, investment assets, fixed assets, and intangible assets. accountants list the assets in their order of liquidity (or ease of converting to cash)
Journal Entries for Assets; debit side
a debit (DR) = increase in assets a credit (CR) = decrease in assets
(2) Short-term investments:
a short term investment is a security (e.g. stocks and bonds) which is marketable an is intended to be held only for a short term. Marketability: means that the security is regularly traded on a continuous trading market (such as stock exchange) at a determinable market price. Holding period: for an investment to be short term, management must intend to convert the investment to cash in the near term, usually within one year.
Investments:
accountants usually list investments after listing current assets on the balance sheet. Unlike the current asset category of short term investments, investments in this account are long term or permanent investments. Thus, an accountant would not list a money market fund as an "investment" on the balance sheet unless the company held it as a long term investment. Accountants usually record real estate, cash, or securities held for some specific purpose (such as pension trust) or for an indefinite period of time as investments.
Accounts payable:
accounts payable are debts arising out of normal business operations that the company expects to pay with current assets. Generally, they arise when a company purchases inventory or supplies on credit.
Notes payable:
an example of a long term liability would be a note payable. A note payable is a written promise to pay a stated sum at a specified date. It may call for a single payment or payment through installments. Notes are either interest bearing or non interest bearing.
Reclassification of Long term liabilities:
as a long-term liability approaches its maturity date, the portion due within the following year is reclassified as a current liability if it will be paid using current assets.
FUNDAMENTAL EQUATION
assets = liabilities + owner's equity
revaluation surplus:
assets are generaly shown on the balance sheet at original costs. Occasionally, fixed assets are written up with the amount by which the asset is revalued, called unrealized surplus.
Assets:
assets are moneys, receivables, or other properties owned by the entity which have a profitable further economic benefit.
