Chapter 4 - The Balance Sheet and Its Analysis Flashcards
Purpose of Balance Sheet
- Systematic organization of everything owned and owed
- Can be complete at any time but is usually prepared at the end of accounting period.
- Provides measured of solvency and liquidity
Accounting Formula
Assets = Liabilities + Owner’s Equity
( Owner’s Equity = Assets - Liabilities )
( Liabilities = Assets - Owner’s Equity )
Solvency
- Measures the liabilities of the business relative to the amount of owner’s equity.
- It provides an indication of the ability to pay off financial obligations if all assets were sold.
- If Assets < Liabilities, the business is insolvent
Liquidity
- Measures the ability of the business to meet financial obligations as they come due without disrupting normal operations.
- Measures the ability to generate cash needed to pay obligations.
- Is generally measured over the next accounting period and is a short-run concept.
Why do Assets have value?
- They can be sold to generate cash
- It can be used to produce other goods that in turn can be sold for cash in the future
Current Assets
- Assets that can be sold easily to generate cash
- The more liquid assets.
- Ex. Cash, Marketable Stocks and Bonds, Accounts Receivable, Inventories.
Noncurrent Assets
- Assets that are more difficult to sell.
Ex. Machinery, Equipment, Livestock, Buildings
Current Liabilities
- Are financial obligations that will become due and payable within 1 year.
- Ex. Accounts Payable, Principal and Accrued Interest on short-term loans.
Noncurrent Liabilities
- Financial obligations that will become due and payable some time after 1 year.
- Ex. Long-term loans
Market Value Asset Valuation
- Fair market price less any transaction costs.
- Works well for items that can be sold in a relatively short time.
Cost Value Asset Valuation
- For purchased items that do not normally lose value
- This method works well for items that have been purchased recently.
- Conservative valuation
Lower of cost or market Asset Valuation
- This method can be used for non-depreciable items.
- Minimizes the chance of placing a high value on a low value item.
Farm Production Cost Asset Valuation
- Accumulated costs of producing the item without including profit.
Cost Less Accumulated Depreciation Asset Valuation
- Only used for assets such as machinery, buildings, and breeding livestock.
- Book value used for items that depreciate
Advantages - Cost vs Market Basis
- Cost: Changes in equity come from retained net income or placing more personal assets into the business, not changes in asset prices.
- Market-Basis: gives more accurate indication of the current financial condition of the company and collateral used it obtaining loans.
