Writing Assignment:
In 725 content words, respond to the following:
Managers within the firm, as well as the firm’s owners and lenders, keep track of the firm’s performance by reviewing its financial statements – income statement, balance sheet, and statement of cash flows.
What is the purpose of the balance sheet? Identify the major types of assets and the claims of creditors and owners shown on the typical balance sheet.
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THE BALANCE SHEET The balance sheet is a statement of a company’s ï¬Ânancial position as of a particular date, usually at the end of a quarter or year. Whereas the income statement reflects the ï¬Ârm’s operations over time, the balance sheet is a snapshot at a point in time. It reveals two broad categories of information: (1) the assets or the ï¬Ânancial and physical items owned by a business and (2) the claims of creditors and owners in the business assets. The creditors’ claims, which are the ï¬Ânancial obligations of the business, are referred to as liabilities . The company’s equity is the funds supplied by the owners and represents their residual claim on the ï¬Ârm. In addition to providing a snapshot of a ï¬Ârm’s ï¬Ânancial condition, the balance sheet reveals much of the inner workings of the company’s ï¬Ânancial structure. The various types of assets indicate the results of recent business operations and the capacity for future operations. The creditors’ claims and the owners’ equity in the assets reveal the sources from which these assets have been derived. The term balance sheet indicates a relationship of equality between the assets of the business and the sources of funds used to obtain them that may be expressed as follows: Assets  Liabilities î€Â Owners equity This “balance sheet equation” or “accounting identity” shows that every dollar of a ï¬Ârm’s assets must be ï¬Ânanced by a dollar of liabilities (typically some type of credit or borrowing), a dollar of owner’s equity, or some combination of the two. The ï¬Ârm’s asset total shows what the ï¬Ârm owns; the total of liabilities and equity shows what the ï¬Ârm owes to its creditors and owners. The balance sheet for the Walgreens shown in Table 13.5 reveals this equality of assets and the ï¬Ânancial interests in the assets. Total assets were $33,462 million in 2012, a 22 percent increase over 2011’s asset level of $27,454 million. Total liabilities increased from $12,607 million to $15,226 million, which is a 21 percent increase. Owner’s equity, which for Walgreens is stockholders’ equity, provided the balancing ï¬Âgure with $18,236 in 2012 and $14,847 in 2011. This was an increase of about 23 percent.
ASSETS
Assets that are most liquid are typically listed ï¬Ârst. By liquidity, we mean the time it usually takes to convert the assets into cash. Two broad groups are identiï¬Âed on the balance sheet: current assets and ï¬Âxed assets. The current assets of a business include cash and other assets that are expected to be converted into cash within one year. Current assets, thus, represent the working capital needed to carry out the normal operations of the business. The principal current assets of a business are typically its cash and marketable securities, accounts receivable, and inventories. Cash and marketable securities include cash on hand and cash on deposit with banks; market-able securities, such as commercial paper issued by other ï¬Ârms; and U.S. government securities in the form of Treasury bills, notes, and bonds. Accounts receivable generally arise from the sale of products, merchandise, or services on credit. The buyer’s debts to the business are generally paid according to the credit terms of the sale. Some ï¬Ârms have notes receivable, which are written promises by a debtor of the business to pay a speciï¬Âed sum of money on or before a stated date. Notes receivable may come into existence in several ways. For example, overdue accounts receivable may be converted to notes receivable at the insistence of the seller or upon special request by the buyer. Notes receivable may also occur as a result of short-term loans made by the business to its employees or to other persons or businesses. The materials and products that a manufacturing ï¬Ârm has on hand are shown as inventories on the balance sheet. Generally, a manufacturing ï¬Ârm categorizes its inventories in terms of raw materials, goods in the process of manufacture, and ï¬Ânished goods. Sometimes, the balance sheet will reveal the amount of inventory in each of these categories. Fixed assets are the physical facilities used in the production, storage, display, and distribution of the products of a ï¬Ârm. These assets normally provide many years of service. The principal ï¬Âxed assets are classiï¬Âed into two categories: (1) plant and equipment and (2) land. Intangible assets, which are assets you cannot see or feel, are accounted for on the balance sheet as they are created as the ï¬Ârm conducts business. An example of this is goodwill , which is an accounting concept as it represents the excess funds paid when one ï¬Ârm merges with or purchases another over and above the accounting value of the ï¬Ârm’s net assets. For example, if a ï¬Ârm’s net assets are worth $100 million but has loyal customers, good workers, or a strong brand image, another ï¬Ârm may pay $125 million to purchase the ï¬Ârm. $25 million will appear on the balance sheet, after the merger, to reflect the value of the goodwill sold in the transaction. In a manufacturing ï¬Ârm, a large investment in plant and equipment is usually required. As products are manufactured, some of the economic value of this plant and equipment lessens. This is called depreciation and accountants reflect this using up of real assets by charging off depreciation against the original cost of plant and equipment. Thus, the net plant and equipment information at any point in time is supposed to reflect their remaining useful lives. The net is calculated by subtracting the amount of depreciation that has accumulated over time from the gross plant and equipment. The topic of depreciation is discussed further in this chapter’s Learning Extension. Some ï¬Ârms own the land or real property on which their buildings or manufacturing plants are constructed. Other ï¬Ârms may own other land for expansion or investment purposes. The original cost of land owned is reflected on the ï¬Ârm’s balance sheet. Under the tax code land cannot be depreciated.
LIABILITIES
Liabilities are the debts of a business. They come into existence through direct borrowing, purchases of goods and services on credit, and the accrual of obligations such as wages and income taxes. Liabilities are classiï¬Âed as current and long-term. The current liabilities of a business may be deï¬Âned as those obligations that must be paid within one year. They include accounts payable, notes payable, and accrued liabilities that are to be met out of current funds and operations. Although the cash on hand plus marketable securi-ties of the Walgreens is $1,297 million compared with current liabilities of $8,722, it is expected that normal business operations will convert receivables and inventory into cash in time to meet current liabilities as they become due. Accounts payable are debts that arise primarily from the purchase of goods and supplies on credit terms. Accounts payable arising from the purchase of inventory on credit terms represent trade credit ï¬Ânancing as opposed to direct short-term borrowing from banks and other lenders. An account payable shown on one ï¬Ârm’s balance sheet appears as an account receivable on the balance sheet of the ï¬Ârm from which goods were purchased. A note payable is a written promise to pay a speciï¬Âed amount of money to a creditor on or before a certain date. The most common occurrence of a note payable takes place when a business borrows money from a bank on a short-term borrowing from banks and other lenders. An account payable shown on one ï¬Ârm’s balance sheet appears as an account receivable on the balance sheet of the ï¬Ârm from which goods were purchased. A note payable is a written promise to pay a speciï¬Âed amount of money to a creditor on or before a certain date. The most common occurrence of a note payable takes place when a business borrows money from a bank on a short-term basis to purchase materials or for other current operating requirements. Current liabilities that reflect amounts owed but not due as of the date of the balance sheet are called accrued liabilities or accruals. The most common forms of accruals are wages payable and taxes payable. These accounts exist because wages are typically paid weekly, biweekly, or monthly and income taxes are paid quarterly. Business debts with maturities greater than one year are long-term liabilities. As we reviewed in Chapter 11, one of the common methods used by businesses for obtaining a long-term loan is to offer a mortgage to a lender as collateral for a corporate bond. In the event that the borrowing business fails to meet the obligations of the loan contract, the mortgage may be foreclosed. That is, the property may be seized through appropriate legal channels and sold to satisfy the indebtedness.
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