basic concepts of balance sheet ppt

basic concepts of balance sheet ppt - Transcript

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Basic Accounting Concepts The Balance Sheet

11 Basic Concepts
1 Money measurement 2 Entity 3 Going concern 4 Cost 5 Dual aspect 6 Accounting period 7 Conservatism 8 Realization 9 Matching 10 Consistency 11 Materiality

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Concept 1 Money Measurement
Accounting records are recorded in monetary terms at value at time transaction is recorded Severe limitation
Can t be valued can t be recorded e g president s health affect of strike Price changes ignored

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Concept 2 Entity
For whom accounts are kept Distinguish from owner May or may not be separate legal entity One entity may be part of a larger entity
General Electric Company presents one set of financial statements with parent company operations combined with all subsidiaries around the world

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Concept 3 Going Concern
Assumed to continue in operation for an indefinite period Alternative assumption
Liquidation bankruptcy Only liquidation values would be meaningful

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Concept 4 Cost
Assets defined
economic resources cash or something that helps generate cash

Assets recorded at cost that is price paid Fair value amount for which asset could be currently purchased or sold Book value of asset recorded value

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Cost Concept Non monetary Assets
Land buildings machinery and similar Generally book value fair value only at time of acquisition Depreciation or amortization systematic allocation of cost over life of asset B V recorded cost depreciation to date Rationale for cost concept
Relevance sacrificed for objectivity
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Cost Concept Monetary Assets
Cash marketable securities Initially recorded at cost Adjusted to fair value market value if available Rationale FV is relevant objective feasible Why is FV relevant objective for monetary assets but not for non monetary assets

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Cost Concept Goodwill
Economic goodwill
Fair value of business fair value of acquired net asset s

Accounting goodwill
Purchase price fair value of net assets Recorded only when purchased Application of cost concept

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Concept 5 Dual Aspect
Assets economic resources Equities claims against assets
Liabilities claims of creditors everyone other than owners Owners equity Shareholders or stockholders equity for a corporation

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Dual Aspect Continued
Fundamental accounting equation
Assets Equities Assets Liabilities Owners equity

For a corporation
Assets Liabilities Stockholders equity Assets Liabilities Paid in capital Retained earnings

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Dual Aspect Concluded
Transactions events that affect accounting records Every transaction has a dual impact on accounting records Dual impact
Results in maintenance of fundamental accounting equation Double entry system
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Balance Sheet
Point in time or status report More formally Statement of Financial Position Contains and shows equality of amounts of
Assets Liabilities and Owners equity

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Interpretations of Dual Aspect Resources and Claims View
Assets Claims on assets Owners equity is a residual claim Shortcomings
Balance Sheet is not at market or liquidating values Owners equity as a claim is unclear Claim is a legalistic view
Better suited to liquidation not to going concern

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Interpretations of Dual Aspect Sources and Uses of Funds View
Right hand side assets how funds used or invested Left hand side liabilities owners equity sources of funds how assets were financed Financing supplied by owners
Paid in capital contributed capital Retained earnings
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Account Categories
Groups of related items Classifications of
Assets Equities i e liabilities owners equity Revenues Expenses

Discretion of management
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Assets
Acquired in a transaction Economic resources i e provide future benefits
Cash or convertible to cash Goods to be sold for cash Items to be used to generate cash

Controlled by the entity Objectively measurable cost at time of acquisition
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Reporting of Assets on Balance Sheet
Grouped into categories Decreasing order of liquidity Current assets almost always shown separately

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Current Assets
Cash Other assets expected to be realized in cash or sold or consumed within longer of one year or normal operating cycle

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Cash
Funds available for disbursement

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Marketable Securities
Investments that are
Readily marketable Expected to be converted to cash within 1 year

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Accounts Receivable
Owed by customers Reported at amount owed less estimated uncollectible Other receivables
Owed by other than customers

Notes receivable
Evidence by written promises to pay notes

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Inventories
Aggregate of those items that are
Held for sale in ordinary course of business In process of production for sale or To be consumed in production of goods or services to be sold

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Exercise
Is a tractor an inventory item or another type of asset for
Caterpillar manufacturer of tractors A farm

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Prepaid Expenses
Intangible Usefulness will expire in near future Examples
Prepaid rent expense Prepaid insurance expense

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Property Plant and Equipment
Also called fixed assets Tangible Long lived Used to produce goods and services to generate cash inflows Land is not depreciated Building and equipment shown at
Cost less accumulated depreciation
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Other Assets
Investments not expected to be sold within a year Intangible assets
Goodwill patents trademarks copyrights Longer life than prepaid expenses

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Liabilities
Obligations to transfer assets or provide services to outside parties Arising from past transactions or events Claims against entity s assets Not against specific assets unless indicated Reported at amount that would satisfy obligations on BS date
Principal interest through BS date
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Current Liabilities
Satisfied or extinguished within one year or current operating cycle whichever is longer

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Accounts Payable
Suppliers i e vendors claims for goods or services furnished but not yet paid Unsecured Notes payable or short term loans
Formal written note Includes amounts owed to financial institutions

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Taxes Payable
Owed to government for taxes Income taxes often shown separately because of size

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Accrued Expenses
Earned by outside parties but not yet paid Usually no invoice Includes interest payable wages payable

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Deferred Revenues
Also called unearned revenues or precollected revenues Advance payment received but company has not yet performed service or delivered product

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Other Liabilities
Current liability
Current Portion of Long Term Debt
Portion due within next year

Long term debt or non current liabilities

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Owners Equity
Amount owners invested in entity Assets Liabilities Net assets For a corporation shareholders or stockholders equity
Shares of stock evidence ownership interest

Could be invested in any assets on Balance Sheet
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Two Categories of Shareholders Equity
Paid in or contributed capital Retained earnings

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Paid in Capital
Capital stock at stated or par value additional paid in capital i e Share Premium Amount owners have paid in to purchase shares of stock

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Retained Earnings
Reinvested earnings from inception to date less dividends to date If negative deficit Residual interest in assets No necessary relation between RE and Cash

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Unincorporated Businesses
Proprietorship
Business owned by one person

Partnership
Business owned jointly by two or more persons

Capital not SE account
Separate for each partner Drawings
Withdrawals by owner s
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Ratios
One number divided by another Example Current ratio
Current Assets Current liabilities A measure of liquidity or ability to pay short term obligations For some industries 2 to 1 is believed desirable

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Balance Sheet Changes Music Mart Start Up
Assets liabilities Paid in capital Retained earnings Dual effect of transactions Transactions
On 1 1 Owner invests 25 000 for stock On 1 2 borrows 12 500 from bank On 1 3 purchases 5 000 of mdse for cash On 1 4 sells mdse for 750 cash that cost 500
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