Financial Statements Outline (The Balance Sheet): Accounting for Lawyers

Financial Statements Outline: Accounting for Lawyers

The Balance Sheet

• “Statement of financial position”
  • Provides information at a certain point in time
  • Lists firm’s assets, liabilities, shareholder’s equity, totals & subtotals
  • Can be represented by:
    • Assets = Liabilities + Shareholder’s Equity
• A common-size balance sheet expresses each balance sheet item as a percentage of total assets = assumes that the size or scale of business does not affect the relation between a given balance sheet item and total assets

Assets

• Asset definition:
  • Probable future economic benefit
  • Firm controls because of a past event or transaction
• Asset recognition:
  • Right to use
  • Results from past transaction
  • Future benefit can be quantified
• Asset Valuation:
  • Historical cost (acquisition cost), example: land, goodwill, intangible finite life
  • Value in use (acquisition cost), example: building, equipment
  • Fair Value (under GAAP: exit value, under IFRS: current exchange value)
  • Present value of future net cash flows (discounts future cash flows to present)
  • Net realizable value (net cash value today), except what if you can’t sell it
• Current assets: Assets that a firm expects to turn into cash, or sell, within one year
  • Cash: short-term, safe, liquid sources of funds- currency on hand, bank deposits, savings accounts, CDs
  • Accounts Receivable (AR): aka receivables- amounts due from customers for sale of goods or services (right to collect from customers, banks use as collateral)
  • Inventory (INV): goods to be sold- can be completed goods, in-process goods, and raw materials
  • Other: prepaid expenses (money paid in advance of goods and services; ex: rent), marketable securities (stocks, bonds, etc, measured by market value)
• Non-current assets: assets held and used for several years
  • Net Property, Plant & Equipment (Net PP&E): long term assets used in operations, including land, buildings, machinery (priced at acquisition cost)
    • Depreciation is a non-cash charge that:
      • Reduces the (net) value of tangible assets on the balance sheets,
      • is an expense on the income statement that reduces earnings
      • is an attempt to capture the deterioration in an asset’s value caused by time and use (though it’s a rough measure)
  • Other: intangibles (patents, trademarks, goodwill= difference between cost of an acquired firm and the value of its individual assets)

Liabilities

• Definition: probable future sacrifices of economic benefits, that arise from present obligations to transfer assets or to provide services in the future as a result of past transaction
• Recognition: represents a present obligation that exists as a result of a past transaction and requires probable future economic resources that can be quantified with sufficient reliability
• Measurement: most liabilities are financial, requiring settlement with cash or other assets
• Current Liabilities: obligations a firm expects to pay within one year
  • Automatic sources: informal liabilities incurred in the ordinary course of business
    • Accounts payable (AP): money owed under informal credit agreement
    • Accrued expenses: expenses incurred through passage of time, but not yet due (utility bills, taxes, wages, etc)
    • Does not include: notes, loans, any other category of debt
  • Debt: Loans, notes, etc. Any liability that is not an automatic source
    • Usually requires interest payments
• Non-current liabilities & shareholder’s equity: sources of funds where the supplier does not expect to receive them all back within a year
• Contingencies: liabilities that are uncertain (timing and/or amount)
  • Recognition criterion under GAAP – no precise threshold, practice indicates approximately 80%