Lecture 5Balance Sheet and Statement of

Cash FlowGapenski Chapter 4

Preview

Balance Sheet

Assets Liability + Owners’ Equity=

Cash

DR CR+

_

A/P

DR CR_

+

Retained Earnings

DR CR_

+

Balance can be maintained by equal debit/ credits – on the same or opposite

sides of the identity.

Balance Sheet

Assets Liability + Owners’ Equity=

Cash

DR CR+

_

A/P

DR CR_

+

Retained Earnings

DR CR_

+

Same side: cash is used to purchase inventory –- credit cash; debit inventoryOpposite side: a loan is taken out and the proceeds put in a cash account – debit cash; credit notes payable

BS Accounts -- permanent

• BS is a snapshot at a moment in time.• Some accounts are easily measurable:

Cash, Investments, A/R• Property, Plant and Equipment (PP&E)

represents a different problem:– Gross PPE – historical cost of everything

bought since inception– Net PPE = Gross PPE – accumulated

depreciation.

What happens on closing?

Property, Plant and Equipment

Dec. 31, 2004 Dec 31, 2005

Gross PP&E 1,476 1,626

Less accum depr 276 320

Net PP&E 1,200 1,306

($k)

How much fixed asset was purchased during 2005?

Assets that don’t feel like assets

• Intellectual property – patents, TM, etc.

• Accounts receivable – credit extended to customers; can be “factored” to a 3rd party (i.e. sold at discount.)

• Prepaid expenses – e.g. may be: insurance, rent, interest on debt, etc.

Expenses vs. expenditures -- Why are prepaid expenses not expensed

immediately when paid?

Prepaid expense accounting

Example – prepay 12 months rent:Date Acct. titles Dr. Cr.10/1 Prepaid rent 12000 Cash 12000When the related period expires, an adjusting

entry is made to convert a proportionate part of prepaid expense asset to a P/(L) item.

Date Acct. titles Dr. Cr.10/31 Prepaid rent 1000 Rent Expense 1000

10/31 exemplifies an adjusting entry.

Valuation of assets

• Valued at historical cost– Tangible (physical assets): buildings,

computers, raw materials…– Intangible non-monetary: prepaid assets,

goodwill, patents, trademarks…

• Valued at market–Monetary: cash, accounts receivable,

stocks/ bonds…

Difference between internally-generated intellectual property and acquired property

Liabilities

• Claims against assets that are set by contract.– Purchases of supplies not yet paid: A/P– Claims by malpractice litigants: not a

liability.

• Current liabilities: expected to be paid within one year

• Long term debt: liabilities that will not be paid off within one year – e.g. a new 30-year mortgage.

Equity• NFPs term assets net of liabilities, “Net

assets” • FPs report “shareholder equity:”– Stock at par– Initial contributed capital– Retained earnings

• Retained earnings are the cumulative reinvestments made in the business

• Source of money for reinvestment is profitHow much of the year’s profits are added to

retained earnings?

Statement of cash flows

• Cash flows from operating activities

• Cash flows from investing activities

• Cash flows from financing activities

From these the net increase (decrease) in cash is developed.

Why is cash so critical?

Problem Assignment

• Gapenski Chapter 4: Problems 4.2, 4.3, 4.4, 4.5, 4.6

• Anthony: cf. syllabus