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Chapter NineLecture Notes

Taking Stock of Where You Are: The Balance Sheet

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Managerial andFinancial Accounting

Managerial Accounting: Internal Focus.

– Plan– Implement– Control

Financial Accounting: External Focus.

– Record events or transactions.– Report financial position and results of operations.

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The Financial Statements

Statement of Financial Position (Balance Sheet) - a snapshot of the resources, obligations, and worth of an organization at a specific point in time.

Activity Statement (Operating or Income Statement) - measures the cumulative resource inflows and outflows for an organization over some specified period of time. It is the reporting equivalent of an operating budget.

Cash Flow Statement - measures the cumulative cash inflowsand outflows for an organization over some specified period oftime. It is the reporting equivalent of a cash budget.

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Financial Statement Concepts

Generally Accepted Accounting Principles from the FASB (not-for-profits) or the GASB (governments) guide the preparation of

financial statements.

Entity Concept requires that you define the organizational component for which you are trying to account.

Money Denominator Convention requires that all items included on the financial statements be measurable in dollar terms.

Objectivity Principle requires that values be based on an objective valuation of resources. When there is a dispute over value, cost is used.

Original (Historical) Cost – assets are recorded at the amount paid for them.

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More Financial Statement Concepts

Conservatism says that you should anticipate and report losses but not gains.

Going Concern Concept assumes that the organization will continue in operation.

Materiality says that reporting only needs to contain the level ofdetail and accuracy necessary for decision making. Financial reports do not need to be exactly accurate.

Accrual Concept states that revenues are recorded when the organization has earned them and expenses are recorded when resources are used to generate revenues.

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Assets = Liabilities + Equity

or

Assets - Liabilities = Equity

What you own - What you owe = What you are worth

The FundamentalAccounting Equation

Resources

Sources of Resources

Claims by Outsiders

Equation must always be in balance!

Residual Assets Owned by Owners

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Statement of Financial Position (The Balance Sheet)

Balance sheet reports:

- what an organization owns (Assets),

- what it owes to outsiders (Liabilities), and

- the portion of the organization's assets owned by its owners. Called– Owner's Equity, Partners' Equity, Net Worth, or

Stockholders’ Equity (for-profit organizations).

– Net Assets or Fund Balance (not-for-profit and governments).

- at a specific point in time. For example, at the end of the organization's Fiscal Year.

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A Personal Balance Sheet

Ms. Jane FrostBalance Sheet

As of December 31, 2011 Assets Liabilities & Net Worth

Liabilities

Cash $ 1,000 Car Loan $ 3,000

Car 12,000 Total Liabilities $ 3,000

Net Worth $10,000

Total Assets $13,000 Liabilities & Net Worth $13,000

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Assets

Assets on the balance sheet are divided into current or short-term(those that are cash or are expected to become cash or will be used up within twelve months) and long-term (those that will not).

Short-Term or Current Assets are listed in order of decliningliquidity and normally include:

- cash,- marketable securities,- accounts receivable,- inventory, and- prepaid expenses

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Meals for the HomelessBalance Sheet

ASSETS LIABILITIES & NET ASSETS

Current Assets Liabilities

Cash $ 1,000 Current Liabilities

Marketable Securities 3,000 Wages Payable $ 2,000

Accounts Receivable, Net 55,000 Accounts Payable 2,000

Inventory 2,000 Notes Payable 6,000

Prepaid Expenses 1,000 Current Portion - Mortgage Payable 4,000

Total Current Assets $62,000 Total Current Liabilities $ 14,000

Long-Term Assets Long-Term Liabilities

Fixed Assets Mortgage Payable $ 12,000

Property $ 40,000 Total Long-Term Liabilities $ 12,000

Equipment, Net 35,000

Investments 8,000 TOTAL LIABILITIES $ 26,000

Total Long-Term Assets $ 83,000 NET ASSETS 119,000

TOTAL ASSETS $145,000 TOTAL LIABILITIES & NET ASSETS $145,000

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Marketable Securities

Marketable securities include equity and debt instruments that can be bought and sold in public and private markets.

The values of Marketable Securities are reported by governments and not-for-profit organizations at fair market value.

For-profit organizations use fair market value for reporting most of their marketable securities.

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Meals for the HomelessBalance Sheet

$145,000TOTAL LIABILITIES & NET ASSETS$145,000TOTAL ASSETS

119,000NET ASSETS$ 83,000 Total Long-Term Assets

$ 26,000TOTAL LIABILITIES 8,000Investments

35,000 Equipment, Net

$ 12,000 Total Long-Term Liabilities$ 40,000 Property

$ 12,000 Mortgage PayableFixed Assets

Long-Term LiabilitiesLong-Term Assets

$ 14,000 Total Current Liabilities$62,000 Total Current Assets

4,000 Current Portion - Mortgage Payable 1,000 Prepaid Expenses

6,000 Notes Payable2,000 Inventory

2,000 Accounts Payable55,000 Accounts Receivable, Net

$ 2,000 Wages Payable3,000 Marketable Securities

Current Liabilities$ 1,000 Cash

LiabilitiesCurrent Assets

LIABILITIES & NET ASSETS ASSETS

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Long-Term Assets

Long-Term Assets are generally divided into three categories:

- Fixed Assets, which include: – property (land) usually recorded at cost, – plant (buildings) originally recorded at cost and later reported

at net book value, and– equipment originally recorded at cost and later reported

at net book value.

- Investments, and

- Intangibles.

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Meals for the HomelessBalance Sheet

$145,000TOTAL LIABILITIES & NET ASSETS$145,000TOTAL ASSETS

119,000NET ASSETS$ 83,000 Total Long-Term Assets

$ 26,000TOTAL LIABILITIES 8,000Investments

35,000 Equipment, Net

$ 12,000 Total Long-Term Liabilities$ 40,000 Property, Net

$ 12,000 Mortgage PayableFixed Assets

Long-Term LiabilitiesLong-Term Assets

$ 14,000 Total Current Liabilities$62,000 Total Current Assets

4,000 Current Portion - Mortgage Payable 1,000 Prepaid Expenses

6,000 Notes Payable2,000 Inventory

2,000 Accounts Payable55,000 Accounts Receivable Net

$ 2,000 Wages Payable3,000 Marketable Securities

Current Liabilities$ 1,000 Cash

LiabilitiesCurrent Assets

LIABILITIES & NET ASSETS ASSETS

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Plant and Equipmenton the Balance Sheet

Recorded at cost when acquired.

Reported net of accumulated depreciation on the balance sheet.

Suppose an organization buys a van for $30,000 and expects touse it for five years and sell it for $5,000. Assuming that the van will be used up evenly over the five years, how would its value appear on the balance sheet at the end of two years?

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A Net Book Value Example

Subtract two years of depreciation[($30,000 - $5,000 salvage)/5 yr life] * 2

= $10,000

Record the Van at Cost $30,000

Net Book Value =$30,000 cost - $10,000 Accum. Deprec. =

$20,000

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Fixed Assets on the Balance Sheet

All three values - cost, accumulated depreciation, and net book value are shown on the balance sheet or in notes that accompany the financial statements. Why?

Museum A Museum B

Are these two museums really similar or different?

Net Fixed Assets or

Net Book Value $ 1,000,000 $ 1,000,000

PP&E at cost $ 40,000,000

$ 2,000,000

Accumulated Depreciation (39,000,000) (1,000,000)

Net Book Value $ 1,000,000 $ 1,000,000

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Recognizing Asset Transactions

Financial events are recorded at the time of Recognition.

Asset transactions are recognized when:- the assets are owned by the organization,- the assets have a monetary value,- that monetary value can be objectively determined.

Which of the following should be recognized as assets?- the amount due on a bill sent to a client?- an LCD computer projector?- a fundraising mailing list developed in an organization?

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Liabilities

Liabilities are categorized as short term and long term depending on when they are due for payment.

Short term usually means coming due in one year or less

Short-term liabilities generally consist of:

- specific "payables" which are typically due within thirty days,- wages or salary payable,- accounts payable, - short term notes payable – i.e., short-term loans, and

- the portion of long-term debt coming due this year

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Meals for the HomelessBalance Sheet

$145,000TOTAL LIABILITIES & NET ASSETS$145,000TOTAL ASSETS

119,000NET ASSETS$ 83,000 Total Long-Term Assets

$ 26,000TOTAL LIABILITIES 8,000Investments

35,000 Equipment, Net

$ 12,000 Total Long-Term Liabilities$ 40,000 Property

$ 12,000 Mortgage PayableFixed Assets

Long-Term LiabilitiesLong-Term Assets

$ 14,000 Total Current Liabilities$62,000 Total Current Assets

4,000 Current Portion - Mortgage Payable 1,000 Prepaid Expenses

6,000 Notes Payable2,000 Inventory

2,000 Accounts Payable55,000 Accounts Receivable, Net

$ 2,000 Wages Payable3,000 Marketable Securities

Current Liabilities$ 1,000 Cash

LiabilitiesCurrent Assets

LIABILITIES & NET ASSETS ASSETS

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Long-Term Liabilities

Long-Term Liabilities are recorded at the Present Value of the required future payments. They include:

- Long-Term Debt:– Capital Leases– Long-Term Unsecured Loans– Long-Term Notes Payable– Mortgages Payable– Bonds Payable

- Pension Liabilities, and

- Contingent Liabilities.

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Meals for the HomelessBalance Sheet

$145,000TOTAL LIABILITIES & NET ASSETS$145,000TOTAL ASSETS

119,000NET ASSETS$ 83,000 Total Long-Term Assets

$ 26,000TOTAL LIABILITIES 8,000Investments

35,000 Equipment, Net

$ 12,000 Total Long-Term Liabilities$ 40,000 Property

$ 12,000 Mortgage PayableFixed Assets

Long-Term LiabilitiesLong-Term Assets

$ 14,000 Total Current Liabilities$62,000 Total Current Assets

4,000 Current Portion - Mortgage Payable 1,000 Prepaid Expenses

6,000 Notes Payable2,000 Inventory

2,000 Accounts Payable55,000 Accounts Receivable, Net

$ 2,000 Wages Payable3,000 Marketable Securities

Current Liabilities$ 1,000 Cash

LiabilitiesCurrent Assets

LIABILITIES & NET ASSETS ASSETS

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Liability Recognition

Liabilities are recognized when: they are legally owed, have to be paid, and the amount to be paid can be measured objectively.

Which of the following should be recognized as a liability? a bill received from a vendor? wages that are due to a worker? a $5 million lawsuit filed against an organization?

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Net Asset Categories

In not-for-profit organizations, Net Worth is called "Net Assets" and is broken down into three categories.

- Unrestricted Net Assets, which have not been restricted by donors

- Temporarily Restricted Net Assets, the use of which has been restricted by donors.

- Permanently Restricted Net Assets, which are restricted inperpetuity.

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Balance Sheet with Net Asset Categories

ASSETS LIABILITIES AND NET ASSETS

Current Assets Liabilities

Cash $ 52,000 Current Liabilities

Accounts Receivable 18,000 Accounts Payable $ 7,000

Inventory 5,000 Wages Payable 30,000

Prepaid Insurance Total Current Liabilities $ 37,000

Total Current Assets $ 75,000 Long-Term Liabilities

Mortgage Payable $140,000

Long-Term Assets Total Long-Term Liabilities $140,000

Fixed Assets Total Liabilities $177,000

Property and Equipment-Net $240,000 Net Assets

Total Long-Term Assets $240,000 Unrestricted $113,000

Temporarily Restricted 15,000

Permanently Restricted 10,000

Total Net Assets $138,000

Total Assets $315,000 Total Liabilities and Net Assets $315,000

0

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Recording Financial Information

A financial event is one that affects the fundamental accounting equation by changing any of its components:

Assets = Liabilities + Net Assets

A journal is a chronological listing of every financial event that occurs in an organization.

Every type of asset, liability, revenue, or expense is referred to as an account. Organizations may have as many accounts as they need.

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A Sample Transaction

Suppose HOS buys inventory for $3,000. We could just add it to assets. But, that puts the Fundamental Equation out of balance.

Assets = Liabilities + Net Assets+$3,000 = no change + no change

We have not "paid" for the supplies. Suppose the seller sent HOS a bill. We would record the full transaction as:

Assets = Liabilities + Net Assets Inventory Accounts Payable

+ $3,000 = + $3,000 + no change

To record a financial event, at least two elements of the fundamental equation must change!

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A One-Sided Change Example

Not every financial event (transaction) results in changes toboth sides of the fundamental equation. Suppose HOS paid for the inventory in cash. Then the transaction would have been recorded as follows:

Assets = Liabilities + Net Assets

Inventory Cash + $3,000 - $3,000 = no change + no change

The fundamental equation is still in balance. But, all of the changes occurred on the left side of the equation!

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Recording Transactions

The first step in recording a transaction is determining what hashappened and what accounts will be impacted.

Suppose near the end of the year, HOS buys a one-year insurance policy for $100 and pays for the policy in cash. Two things have happened:

- Cash has gone down by $100.- HOS owns a new $100 asset called "prepaid insurance."

Here's the way the transaction would be recorded:

Assets = Liabilities + Net Assets P/I Cash + $100 - $100 = no change + no change

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Another Example

HOS mails a check to its bedpan supplier for $2,000 to pay part of the $7,000 it owed them at the start of the year. Two things have happened:

- Cash has gone down by $2,000.

- HOS's accounts payable have decreased by $2,000.

Here's the way the transaction would be recorded:

Assets = Liabilities + Net Assets

Cash = Accounts Payable - $2,000 = - $2,000 + no change

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Collection Example

HOS receives $12,000 from customers. This was owed to HOS for care provided during the previous year.

- Cash has gone up by $12,000.

- HOS's accounts receivable have decreased by $12,000.

Here's the way the transaction would be recorded:

Assets = Liabilities + Net Assets

Cash Accounts Receivable + $12,000 - $12,000 = No change on right side.

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Generating a Balance Sheet

Generating a balance sheet involves:

- Beginning with the starting balance sheet,

- Recording all of the transactions for the period,

- Adding the impact of the transactions to the starting balance sheet,

- Calculating the ending balances for all accounts

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The Starting Balance Sheet

ASSETS LIABILITIES AND NET ASSETS

Current Assets Liabilities

Cash $ 52,000 Current Liabilities

Accounts Receivable 18,000 Accounts Payable $ 7,000

Inventory 5,000 Wages Payable 30,000

Prepaid Insurance 0 Total Current Liabilities $ 37,000

Total Current Assets $ 75,000 Long-Term Liabilities

Mortgage Payable $140,000

Long-Term Assets Total Long-Term Liabilities $140,000

Fixed Assets Total Liabilities $177,000

Property and Equipment, Net $240,000

Total Long-Term Assets $240,000 Total Net Assets 138,000

Total Assets $315,000 Total Liabilities and Net Assets $315,000

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Transactions Work Sheet

ASSETS LIABILITIES & NET ASSETS

Cash

Accounts

Receivable Inventory

Ppd.

Ins.

Plant &

Equipment

Accounts

Payable

Wages

Payable

Mortgage Payable

Net

Assets

Beginning

Balance

$52,000 $18,000 $5,000 $ 0 $240,000 $7,000 $30,000 $140,000 $138,000

Buy Inventory

3,000 3,000

Pay for Fire Ins.

(100) 100

Pay for Inventory

(2,000) (2,000)

Receive

Payment 12,000 (12,000) _____ ____ _______ _____ ______

______

______

Ending Balance

$61,900 $ 6,000 $8,000 $100 $240,000 $8,000 $30,000 $140,000 $138,000

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The Ending Balance Sheet

ASSETS LIABILITIES AND NET ASSETS

Current Assets Liabilities

Cash $ 61,900 Current Liabilities

Accounts Receivable 6,000 Accounts Payable $ 8,000

Inventory 8,000 Wages Payable 30,000

Prepaid Insurance 100 Total Current Liabilities $ 38,000

Total Current Assets $ 76,000 Long-Term Liabilities

Mortgage Payable $140,000

Long-Term Assets Total Long-Term Liabilities $140,000

Fixed Assets Total Liabilities $178,000

Property and Equipment, Net $240,000

Total Long-Term Assets $240,000 Total Net Assets 138,000

Total Assets $316,000 Total Liabilities and Net Assets $316,000