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The Balance
Sheet and
Notes to the
Financial
Statements
2
Learning Objectives
 Describe the specific elements of the
balance sheet (assets, liabilities, and
owners’ equity) and prepare a balance
sheet with assets and liabilities properly
classified into current and noncurrent
categories.
 Identify the different formats used to
present balance sheet data.
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Learning Objectives
 Analyze a company’s performance and
financial position through the
computation of financial ratios.
 Recognize the importance of the notes
to the financial statements, and outline
the types of disclosures made in the
notes.
 Understand the major limitations of the
balance sheet.
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Usefulness of the Balance Sheet
• Reports the resources (assets), obligations
(liabilities), and residual ownership
claims (equity) of a company.
• Facilitates analysis of the company’s
ability to:
– meet short-term obligations (liquidity).
– pay all debts as due (solvency).
• Provides information about the company’s
financial flexibility.
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Elements of the Balance Sheet
Assets
Probable future
economic benefit
obtained or
controlled by a
particular entity as
a result of past
transactions or
events
The inclusion of
“probable”
acknowledges
that accounting
is not an exact
science.
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Elements of the Balance Sheet
Assets
Probable future
economic benefit
obtained or
controlled by a
particular entity as
a result of past
transactions or
events
The primary
purpose of the
balance sheet is
to help forecast
the future.
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Elements of the Balance Sheet
Typical assets found on a
balance sheet are cash,
supplies, accounts
receivable, land, buildings,
and equipment.
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Elements of the Balance Sheet
“Obligation”
includes legal,
moral, social,
and implied
commitments.
Liability
Probable future sacrifice
of economical benefit
arising from a present
obligation of a particular
entity to transfer assets or
provide services to other
entities in the future as a
result of past transactions
or events.
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Elements of the Balance Sheet
Liability
An obligation to
provide services
is a liability.
Probable future sacrifice
of economical benefit
arising from a present
obligation of a particular
entity to transfer assets or
provide services to other
entities in the future as a
result of past transactions
or events.
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Elements of the Balance Sheet
Typical liabilities include
accounts payable, notes
payable, and advances
from customers.
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Elements of the Balance Sheet
Equity
Residual interest in the assets of an entity
that remains after deducting its liabilities.
Capital Stock
Paid-in Capital in Excess of Par
Retained Earnings
How to Classify Items on
the Balance Sheet
 Current (one
year or less)
 Noncurrent
(more than 1
year)
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Current Assets
Cash and resources expected to be
converted to cash during the
entity’s normal operating cycle or
one year, whichever is longer,
are current assets.
•
•
•
•
Cash
Accounts and notes receivable
Inventories
Prepaid items
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Operating Cycle
Cash
Collections
Purchases
Inventories
Receivables
Sale
s
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Noncurrent Assets
• Investments
• Property,
plant, and
equipment
• Deferred
income taxes
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Property, Plant, and Equipment
Property, plant, and
equipment are
properties of a
tangible and
relatively permanent
nature that are used in
the normal business
operations.
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Intangible Assets
Intangible assets are
long-term rights and
privileges of a
nonphysical nature
acquired for use in
business operations.
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Current Liabilities
Current liabilities are obligations
expected to be paid within one year
or the normal operating cycle.
• Accounts and notes payable
• Accrued expenses
• Current portion of long-term
obligations
• Unearned revenues
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Current Liabilities
If the terms of the
agreement for a callable
obligation is due on
demand or will become
due on demand within
one year from the
balance sheet date, the
obligation should be
classified as current.
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Noncurrent Liabilities
The current liability classification generally
does not include the following items:
 Debts to be liquidated from a noncurrent
sinking fund.

Short-term obligations to be refinanced.
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Noncurrent Liabilities
• Long-term debt
• Long-term lease
obligations
• Deferred income
tax liability
• Pension
obligations
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Noncurrent Liabilities
Long-term debt is reported
at its discounted present
value.
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Contingent Liabilities
Past activities or
circumstances may
give rise to possible
future liabilities.
Potential obligations
that do not exist on
the balance sheet
date are known as
contingent liabilities.
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Contingent Liabilities
An estimated liability is a
definite liability, so it is
not a contingent liability.
Owners’ Equity
Contributed Capital:
Capital stock usually is
 Capital stock the number of shares
issued multiplied by the
 Additional paid-in
par capital
or stated value.
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Owners’ Equity
Contributed Capital:
The two types of capital
 Capital stock stock are preferred and
common.
 Additional paid-in capital
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Owners’ Equity
Additional paid-in
Contributed Capital:
capital is the excess
 Capital stock invested above par or
stated value of the
 Additional paid-in capital
capital
stock.
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Owners’ Equity
Retained earnings is the
amount of undistributed
earnings of past periods.
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Evaluating Liquidity
 Current Ratio: current assets divided by
current liabilities.
 Quick Ratio: quick assets divided by
current liabilities (Acid-Test Ratio).
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Liquidity Ratios Example
Cash
Net Accounts Receivable
Current Ratio
Inventory
Current Assets
Current Liabilities
Current
Assets
$200
Current$100
Liabilities
$ 30
70
100
$200
$100
= 2:1
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Liquidity Ratios Example
Cash
Net Accounts Receivable
Inventory Quick Ratio
Current Assets
Current Liabilities
$100
Quick
Assets
Current$100
Liabilities
$ 30
70
100
$200
$100
= 1:1
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Current Ratio
McDonald’s
0.5
Microsoft
2.8
Disney
1.2
Coca-Cola
0.7
Yahoo!
5.8
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Overall Leverage
Debt Ratio: total liabilities divided by
total assets.
Total Assets
$400
Total Liabilities
300
Total $300
Liabilities
$400
Total
Assets
= 75%
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Debt Ratio
McDonald’s
52.2%
Microsoft
25.6%
Disney
53.1%
Coca-Cola
56.1%
Yahoo!
13.8%
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Asset Mix
The proportion of total assets in each
asset category.
Property, Plant, and Equipment
Total Assets
Asset$50
Group
$400
Total
Assets
$ 50
400
= 12.5%
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Efficiency
“Asset Turnover” is a financial ratio
measuring how efficiently a company
uses its assets to generate sales.
Sales
$200
Total Assets
400
Sales
$200
Total
Assets
$400
= 0.50
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Asset Turnover
McDonald’s
0.63
Microsoft
0.65
Disney
0.56
Coca-Cola
0.98
Yahoo!
0.33
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Overall Profitability
Two ratios that measure overall
profitability are “Return on Assets” and
“Return on Equity.”
Return on Assets
Net Income
Total Assets
Stockholders’ Equity
Net $40
Income
$400
Total
Assets
$ 40
400
160
= 10.0%
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Return on Assets
McDonald’s
Microsoft
Disney
Coca-Cola
Yahoo!
7.8%
20.2%
4.5%
18.5%
4.1%
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Overall Profitability
Two ratios that measure overall
profitability are “Return on Assets” and
“Return on Equity.”
Return on Equity
Net Income
Total Assets
Stockholders’ Equity
Net $40
Income
$160 Equity
Stockholders’
$ 40
400
160
= 0.25%
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Return on Equity
McDonald’s
16.4%
Microsoft
27.0%
Disney
Coca-Cola
Yahoo!
9.5%
42.0%
4.8%
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Notes to Financial Statements
• Summary of significant accounting
policies.
• Additional information to support
summary totals.
• Information about items not included
in financial statements.
• Supplementary information required
by the FASB or the SEC to fulfill the
full-disclosure principle.
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Subsequent Events
Balance
Sheet Date
Financial Statement
Period
Events in this period
may affect the reporting
of amounts in the
subsequent periods
Date Statements
Issued
Subsequent
Period
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Subsequent Events
Balance
Sheet Date
Financial Statement
Period
Date Statements
Issued
Subsequent
Period
•Types of Events
•Those that materially affect one or more financial
statements.
•Those that create a need for a footnote.
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Limitations of the Balance Sheet
 Does not disclose actual value of the
entity.
 Does not disclose effects of inflation.
 Classifications are not uniform among
companies.
 Does not disclose all assets and
liabilities.
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The End