This module provides an introduction to the balance sheet one of the essential financial statements in accounting and includes an introduction to debits and credits and double entry accounting We suggest doing the Balance Sheet module prior to the Income Statement ID: 142623
Download Presentation The PPT/PDF document "Balance Sheet" is the property of its rightful owner. Permission is granted to download and print the materials on this web site for personal, non-commercial use only, and to display it on your personal computer provided you do not modify the materials and that you retain all copyright notices contained in the materials. By downloading content from our website, you accept the terms of this agreement.
Slide1
Balance Sheet
This module provides an introduction to the balance sheet, one of the essential financial statements in accounting and includes an introduction to debits and credits, and double entry accounting. We suggest doing the Balance Sheet module prior to the Income Statement.
Author: Stu James© 2014 Stu James and Management by the Numbers, Inc.Slide2
The balance sheet is one of the essential financial statements (reports) for a company and is a required filing for all public companies.
Understanding how to read and interpret a balance sheet is an important skill for a business person or investor.The balance sheet provides important information about the financial health of a company at a particular point in time – a “snapshot”. This information includes:
Assets (what the company owns)Liabilities (what the company owes)Shareholder’s Equity (what is left for shareholders)Introduction to the Balance Sheet2Introduction to the Balance Sheet
MBTN | Management by the NumbersSlide3
Sample Balance Sheet
3Sample Balance Sheet
MBTN | Management by the NumbersFacebook, Inc.As of Sept 30, 2013$MillionsAssets14,933Liabilities1,885Shareholder Equity13,048
Here is a (very) simplified balance sheet for
Facebook
, Inc. as of Sept 30, 2013.
Facebook’s
balance sheet consists of three major categories.
What else can we say?
First, note that
Assets = Liabilities + Shareholder Equity
($14,933 = $1,885 + $13,048)
This must always be true!
Second, note that the figures are as of Sept 30, 2013, a particular moment in time.
We can also say that
Facebook’s
assets (what it owns) far outweighs its liabilities (what it owes).
Now let’s look at these three parts of the balance sheet in more detail.Slide4
Legal Rights4
Legal Rights
MBTN | Management by the NumbersFacebook, Inc.$MillionsAssetsProperty14,933LiabilitiesPrimary Rights1,885
Shareholder Equity
Secondary
Rights
13,048
Another way to look at this is a more formal legal definition where we have property (assets) and two general classes of property rights (liabilities and shareholder equity).
So we can also say that
Facebook
has $14,933 of property, of which $1,885 is claimed through liabilities, and $13,048 is left for shareholders. Legally, this is generally how it works.Slide5
Assets5
Assets
MBTN | Management by the NumbersFacebook, Inc. Assets$Millions Cash and Cash Equivalents3,100 Short-Term Investments6,228 Receivables879
Inventory
0
Other Current Assets
342
Total Current Assets
10,549
Plant,
Property and Equipment
2,685
Intangible Assets
1,609
Other Assets
90
Total Assets
14,933
Let’s look at
Facebook’s
assets in more detail:
First, note that assets are divided into current assets and non-current assets. Examples of current assets include cash, CDs, marketable securities (stocks and bonds), accounts receivable (payments owed to a company by customers), inventory, and pre-paid expenses (when a company pays a bill in advance).
Definition: Current Assets
are those assets which can reasonably be expected to be converted into cash within one year.Slide6
Assets6
Assets
MBTN | Management by the NumbersFacebook, Inc. Assets$Millions Cash and Cash Equivalents3,100 Short-Term Investments
6,228
Receivables
879
Inventory
0
Other Current Assets
342
Total Current Assets
10,549
Plant,
Property and Equipment
2,685
Intangible Assets
1,609
Other
Assets
90
Total Assets
14,933
Now let’s consider non-current assets:
Examples of non-current assets include buildings, vehicles, operating plants, equipment, office furniture, and intangible assets. Intangible assets would include intellectual property and goodwill. Most long-term assets are depreciated or amortized over time. Depreciation and amortization represent how a long-term asset gets used up over time.
Definition: Non-Current Assets
are longer-term assets that are not expected to be liquidated. These are depreciated or amortized over time.Slide7
Liabilities7
Liabilities
MBTN | Management by the NumbersFacebook, Inc. Liabilities$Millions Accounts Payable489 Short-Term Debt459 Other Current Liabilities
36
Total Current Liabilities
984
Long Term Debt
287
Other Liabilities
614
Total Liabilities
1,885
Let’s look at
Facebook’s
liabilities in more detail:
Just like current assets, current liabilities are those debts that are expected to be paid during the coming year. Examples of current liabilities include accounts payable (what a company owes vendors for products or services purchased), taxes payable, debt of less than one year or debt coming due within a year (bonds that mature in the coming year).
Definition: Current Liabilities
are
those debts
which are expected to
be paid within the coming year.Slide8
Liabilities8
Liabilities
MBTN | Management by the NumbersFacebook, Inc. Liabilities$Millions Accounts Payable489 Short-Term Debt459 Other Current Liabilities
36
Total Current Liabilities
984
Long Term Debt
287
Other Liabilities
614
Total Liabilities
1,885
Now let’s consider
Facebook’s
long-term liabilities:
Long-term liabilities include items such as long-term bonds with a maturity date over a year, real estate loans, and other long-term bank loans.
Definition: Long-Term Liabilities
are those debts which are expected to be repaid more than a year in the future.Slide9
Shareholder Equity9
Shareholder Equity
MBTN | Management by the NumbersFacebook Shareholder Equity$Millions Retained Earnings2,636 Capital Surplus10,399 Other Shareholder Equity13
Total Shareholder Equity
13,048
Now let’s look at
Facebook’s
Shareholder Equity:
Shareholder equity includes retained earnings (from the Income Statement), Capital Surplus (any initial or subsequent investment in the company by shareholders beyond the par value of the stock). In addition, the par value of any preferred or common stock would be listed here separately.
Definition: Shareholder Equity
accounts are the residual accounts – what would be left for the shareholders after all liabilities are paid.
Insight
Equity accounts represent the (residual) value of the company (or, assets minus liabilities)Slide10
Transactions10
Transactions
MBTN | Management by the NumbersAn accounting transaction is an event that must be recorded in a company’s accounting system that impacts the balance sheet and/or income statement. These are also call journal entries. Let’s look at a few simple transactions that impact the balance sheet so you can better understand how the balance sheet works in practice.Consider the following transaction events:Receiving a 30 day loan as a $1,000 cash deposit from a bankObtaining $5,000 from an investorBuying $3,000 of inventory with cash
Paying a $3,000 bill owed to vendor
Receiving a $500 wire payment from an international customer
How do these transactions impact the balance sheet?Slide11
Transactions11
Transactions
MBTN | Management by the NumbersReceiving a $1,000 loan will impact two areas as shown below. It will increase your cash balance by $1,000 and increase your short-term liabilities by $1,000 (maintains assets = liabilities + shareholder eq.). AssetsLiabilitiesShareholder EquityCashS-T Liabilities
+$1000 =
+$1000
+ $0
Obtaining $5000 from an investor will also increase your cash balance. But instead of a liability, the offsetting entry is capital surplus under equity (maintains assets = liabilities + shareholder equity).
Assets
Liabilities
Shareholder Equity
Cash
Capital Surplus
+$5000 =
+$0
+ $5000Slide12
Transactions12
Transactions
MBTN | Management by the NumbersBuying $3,000 of inventory with cash only impacts the asset side of the balance sheet as shown, but the net effect maintains the equation.AssetsLiabilitiesShareholder EquityInventory+$3000 =
+$0
+$0
Cash
-$3000 =
+$0
+$0
$3000 -$3000 =
+$0
+$0
What if the inventory is purchased on credit with the vendor, instead?
Assets
Liabilities
Shareholder Equity
Inventory
Accounts Payable
$3000 =
+$3000
+$0Slide13
Transactions13
Transactions
MBTN | Management by the NumbersWhen the vendor sends an invoice for the inventory and it is paid with cash, cash will decrease and so will accounts payable.AssetsLiabilitiesShareholder EquityCashAccounts Payable
-$3000 =
-$3000
+$0
Note that the net on the accounts payable account is zero for the last two transactions. Paying on credit, instead of using cash, basically creates a temporary condition of a short-term liability, called accounts payable (A/P).
Take a moment to recognize that the net impact of a cash purchase of inventory is the same as a purchase on credit after paying the vendor. The accounting system just records the fact that the company owes the vendor a payment for the inventory, which is reflected in liabilities.Slide14
Transactions14
Transactions
MBTN | Management by the NumbersReceiving a $500 wire payment from a customer is kind of the flip side of paying a vendor for inventory already received. Here, a customer owes you money (recorded in accounts receivable), and pays it, removing the expected, but not yet received, payment owed by the customer.AssetsLiabilitiesShareholder EquityCash
+$500 =
+$0
+$0
Accounts Receivable
-$500 =
+$0
+$0
+$500 - $500 =
+$0
+$0
Just like the purchase of inventory earlier, this transaction only impacts the balances on the asset side of the balance sheet.Slide15
Debits and Credits15
Debits and Credits
MBTN | Management by the NumbersThis module provides basic understanding of how balances change with transactions. We’d be remiss if we didn’t mention one additional dimension to transactions – credits and debits.Every accounting transaction consists of one or more credits and offsetting debits such that the balance sheet equation is maintained (assets = liabilities + shareholder equity). You can have debits and credits in each major category of the balance sheet. What matters is that credits = debits and that change in assets = change in liabilities + shareholder equity!Definition: For every transaction,
Credits = Debits
Assets = Liabilities + Shareholder Equity - and -
Net Change in Assets = Net Change in (Liabilities + Shareholder Equity)Slide16
Debits and Credits16
Debits and Credits
MBTN | Management by the NumbersAccount CategoryDebit / CreditIncrease / DecreaseAssetDebitIncreaseAssetCredit
Decrease
Liability
Debit
Decrease
Liability
CreditIncrease
Equity
Debit
Decrease
Equity
Credit
Increase
The table below is a summary that you can use to determine if a transaction is a debit or a credit, or whether it will increase or decrease the balance of the account category.
So, rather than putting in a negative number to decrease an asset account, we credit it. Rather than putting in a negative number to decrease a liability account, we debit it.Slide17
Debits and Credits17
Debits and Credits
MBTN | Management by the NumbersThe system of using debits and credits, or double entry bookkeeping, originated in Venice over 500 years ago. The system is still in use today, though obviously modernized through the use of computers. Computers have vastly improved on the manual approach of “T” tables, but the approach is still the backbone of the system.InsightWhile the computer ensures that values balance, the data entered must be accurate and the right accounts must be chosen or the balance sheet will not be an accurate portrayal of the company’s position.
Assets
Liabilities
Shareholder Equity
Cash
S-T
Liabilities
Debits
Credits
Debits
Credits
Debits
Credits
$1000
$1000
“T” TableSlide18
Debits and Credits18
Debits and Credits
MBTN | Management by the NumbersNow let’s try our examples again, but using the full system of debits and credits, as well as showing the impact on the account.Receiving a 30 day loan as a $1000 cash deposit from a bankObtaining $5000 from an investorBuying $3000 of inventory with cashPaying a $3000 bill owed to vendor
Receiving a $500 wire from an international customer
Here is the entry for the first transaction. Now try the others:
Assets
Liabilities
Shareholder Equity
Cash
S-T
Liabilities
Debits
Credits
Debits
Credits
Debits
Credits
$1000
$1000
Increase
Increase
No changeSlide19
Debits and Credits19
Debits and Credits
MBTN | Management by the NumbersObtaining $5,000 from an investorAssetsLiabilitiesShareholder EquityCash
Capital Surplus
Debits
Credits
Debits
Credits
Debits
Credits
$5000
$5000
Increase
No change
Increase
The cash account is debited (increases) by $5,000 and the capital surplus account is credited (also increases) by $5,000. Debits and credits are equal ($5,000 = $5,000). Change in assets = Change in liabilities + shareholder equity ($5,000 = $5,000)Slide20
Debits and Credits20
Debits and Credits
MBTN | Management by the NumbersBuying $3,000 of inventory with cashAssetsLiabilitiesShareholder EquityCash
Debits
Credits
Debits
Credits
Debits
Credits
$3000
Inventory
Debits
Credits
Debits
Credits
Debits
Credits
$3000
Cash decreases (credit) and Inventory
increases (debit), but no net change in assets.
No change
No changeSlide21
Debits and Credits21
Debits and Credits
MBTN | Management by the NumbersIf instead, the inventory had been purchased on credit (terms)…AssetsLiabilitiesShareholder EquityInventory
Accounts Payable
Debits
Credits
Debits
Credits
Debits
Credits
$3000
$3000
Increase
Increase
No Change
Later, paying the $3,000 bill owed to that same vendor
Assets
Liabilities
Shareholder Equity
Cash
Accounts Payable
Debits
Credits
Debits
Credits
Debits
Credits
$3000
$3000
Decrease
Decrease
No ChangeSlide22
Debits and Credits22
Debits and Credits
MBTN | Management by the NumbersReceiving a $500 wire payment from an international customerAssetsLiabilitiesShareholder EquityCash
Debits
Credits
Debits
Credits
Debits
Credits
$500
Accounts Receivable
Debits
Credits
Debits
Credits
Debits
Credits
$500
Cash increases (debit) and Accounts
Payable decreases (credit), but no net change in assets.
No change
No changeSlide23
Building a Balance Sheet
23Building a Balance Sheet
MBTN | Management by the NumbersThe last example we’ll use is to create a balance sheet from scratch for a start-up coffee shop. While this is obviously a very simplified exercise, it will help you understand how the transactions build together to create the balance sheet.On the next page, there are 7 transactions that you can use to test your comprehension. Try to build it yourself before checking the answer key. We’ve also provided the detail on all the individual transactions so you can follow how the accounts were updated.Slide24
Building a Balance Sheet
24Building a Balance Sheet
MBTN | Management by the NumbersCreate a balance sheet from the following transactions:An investor starts the company with $25,000 of cash.The manager obtains a $15,000 long-term loan from a local bank. The manager purchases an espresso maker for $1,500 on credit.The manager purchases a computer for $1,000 for cash.
The manager purchases $2,500 of goods to resell (inventory) using cash.
The manager signs a 3 year contract to rent a building space that requires a $1,000 deposit and first month’s pre-paid rent of $1,000.
The manager writes the check for the deposit and rent.
Ready, set, go
– don’t advance until you’ve tried it!Slide25
Building a Balance Sheet
25Building a Balance Sheet
MBTN | Management by the NumbersAssets$ Cash$34,500 Inventory$2,500 Pre-Paid Rent$1,000
Current Assets
$38,000
Equipment
$2,500
Deposit
$1,000
Total Assets
$41,500
Liabilities
$
Accounts Payable
$1,500
Current Liabilities
$1,500
L-T Liabilities
$15,000
Total Liabilities
$16,500
Shareholder Equity
$
Capital Surplus
$25,000
Total SH Equity
$25,000
Total
Liab
. + Equity
$41,500
Though very simple (and only including transactions that impact the balance sheet alone), this exercise provides a good sense of how the balance sheet changes over time. The detail of the transactions and T accounts are shown on the following pages for reference.Slide26
Building a Balance Sheet
26Building a Balance Sheet
MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash
Capital Surplus
Debits
Credits
Debits
Credits
Debits
Credits
$25,000
$25,000
Increase
No change
Increase
Assets
Liabilities
Shareholder Equity
Cash
Long-Term
Liab
.
Debits
Credits
Debits
Credits
Debits
Credits
$15,000
$15,000
Increase
Increase
No Change
Assets
Liabilities
Shareholder Equity
Equipment (or PPE)
Accounts Payable
Debits
Credits
Debits
Credits
Debits
Credits
$1,500
$1,500
Increase
Increase
No ChangeSlide27
Building a Balance Sheet
27Building a Balance Sheet
MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash
Debits
Credits
Debits
Credits
Debits
Credits
$1,000
Equipment
Debits
Credits
Debits
Credits
Debits
Credits
$1,000
No net change
in Assets
No change
No change
Assets
Liabilities
Shareholder Equity
Cash
Debits
Credits
Debits
Credits
Debits
Credits
$2,500
Inventory
Debits
Credits
Debits
Credits
Debits
Credits
$2,500
No net change
in Assets
No change
No changeSlide28
Building a Balance Sheet
28Building a Balance Sheet
MBTN | Management by the NumbersAssetsLiabilitiesShareholder EquityCash
Debits
Credits
Debits
Credits
Debits
Credits
$2,000
Prepaid Rent
Debits
Credits
Debits
Credits
Debits
Credits
$1,000
Deposits
Debits
Credits
Debits
Credits
Debits
Credits
$1,000
No net change
in Assets
No change
No change
Signing the contract generally does not create an accounting transaction, only when the deposit and pre-paid rent is actually paid.Slide29
MBTN Income
Statement Module. This MBTN module provides a similar introduction to the income statement. Financial Statements– Further Reference
29Financial Statements - Further ReferenceMBTN | Management by the Numbers