2. OutlineOutline
• Purpose and Use of a Balance Sheet
• Balance Sheet Format
• Asset Valuation and Related
Problems
• Balance Sheet Example
• Balance Sheet Analysis
• Statement of Owner Equity
3. ObjectivesObjectives
1. To discuss the purpose of a balance
sheet
2. To illustrate the format and structure of
a balance sheet
3. To outline some problems when valuing
assets and the recommended valuation
methods for different types of assets
4. To show the difference between a cost
and market basis
5. To define owner equity or net worth and
show its importance
6. To analyze solvency and liquidity
7. To introduce and explain statement of
owner equity
4. Purpose and Use of a BalancePurpose and Use of a Balance
SheetSheet
• Systematic organization of
everything “owned” and “owed”
• Assets = liabilities + owner equity
• Owner equity = assets − liabilities
• Can be completed at any time, but
mostly prepared at end of
accounting period
• Provides measures of solvency and
liquidity
5. SolvencySolvency
Solvency measures the liabilities of
the
Business relative to the amount of
owner
equity invested in the business. It
provides an indication of the ability
to pay
off all financial obligations or
liabilities if
all assets were sold.
6. LiquidityLiquidity
Liquidity measures the ability of the
business
to meet financial obligations as they come
due
without disrupting the normal operations of
the business. Liquidity measures the
ability
to generate cash needed to pay obligations.
Liquidity is generally measured over the
next
accounting period and is a short-run
concept.
7. Balance Sheet FormatBalance Sheet Format
• Assets shown on left or top
• Liabilities are shown on right or
below assets
• Owner equity shown on balance
sheet and liabilities + owner equity
= assets
8. General Format of a BalanceGeneral Format of a Balance
SheetSheet
$100 $60
400 200
$260
240
$500 $500Total Assets
Total Liabilities
Owner's Equity
Total Liabilities and
Owner's Equity
Noncurrent Assets
Current Assets Current Liabilities
Noncurrent Liabilities
Assets Liabilities
9. AssetsAssets
An asset has value for one of
two
reasons:
1. It can be sold to generate
cash, or
2. It can be used to produce
other goods that in turn can
be sold for cash in the future.
10. Current AssetsCurrent Assets
Assets that can be sold easily to
generate
cash are called liquid assets.
Accounting
principles require current assets,
which
are the more liquid assets, to be
separated
from other assets on the balance
sheet.
Current assets include: cash,
marketable
stocks and bonds, accounts
11. Non-current AssetsNon-current Assets
• Assets that are not current
assets are classified as non-
current assets. They are more
difficult to sell and/or their
sale would be more likely to
disrupt the business.
• Non-current assets include:
machinery, equipment,
breeding livestock, buildings,
and land.
13. Current LiabilitiesCurrent Liabilities
Accounting principles require that current
liabilities be separated from other
liabilities
on the balance sheet. Current liabilities
are
financial obligations that will become due
and
payable within one year from the date on
the
balance sheet.
Examples: accounts payable, principal and
accrued interest on short-term loans, and
principal due within one year on longer
14. Non-current LiabilitiesNon-current Liabilities
Any liability that is not current
is
classified as a non-current
liability.
These financial obligations will
become due and payable some
time
after one year from the date on
the
15. Owner EquityOwner Equity
If all assets were to be sold and all debts
paid
on the date of the balance sheet, the
owner’s
equity would be the amount left over.
Owner
equity changes when: 1) the business has
a
profit or loss 2) the owner invests more
capital
from outside the business or withdraws
money
from the business, or 3) assets change
value.
16. Alternative FormatAlternative Format
Current assets and current liabilities are defined
in the same way as previously defined.
Intermediate assets are expected to have a useful
life of 1 to 10 years and intermediate liabilities are
due and payable after 1 year, but before 10 years.
Fixed assets have a useful life of more than 10
years and long-term liabilities are due after 10
years.
17. Format of a Three-CategoryFormat of a Three-Category
Balance SheetBalance Sheet
$100 $60
120 75
280 125
$260
240
$500 $500
Current Assets Current Liabilities
Long-term Liabilities
Assets Liabilities
Total Assets
Intermediate Assets Intermediate Liabilities
Total Liabilities
Owner's Equity
Total Liabilities and
Owner's Equity
Fixed Assets
18. Asset Valuation and RelatedAsset Valuation and Related
ProblemsProblems
A cost-basis balance sheet has all
assets
valued following the cost, cost less
depreciation, or farm production cost
methods. The one exception would
be
inventories of grain and market
livestock.
A market-basis balance sheet has all
assets valued at market value less
19. Which BS is best?Which BS is best?
Cost-basis balance sheets conform to
general accounting standards and are thus
comparable to balance sheets from other
types
of businesses.
Market-basis balance sheets more
accurately
reflect the actual financial position.
FFSC says both types of balance sheets are
needed for proper business analysis.
20. Valuation Methods for Cost-BasisValuation Methods for Cost-Basis
andand
Market-Basis Balance SheetsMarket-Basis Balance Sheets
Cost Market
Basis Basis
Marketable securities Cost Market
Inventories of grain and
market livestock Market* Market
Accounts receivable Cost Cost
Prepaid expenses Cost Cost
Investment in growing crops Cost Cost
Purchased breeding livestock Cost Market
Raised breeding livestock Cost or a Market
base value
Machinery and Equipment Cost Market
Buildings and Improvements Cost Market
Land Cost Market
market livestock
Lower of cost or market is preferred for purchased grain and
Asset
*Market is acceptable for raised grain and market livestock
21. Balance Sheet for DPIMBalance Sheet for DPIM
Farmer, December 31, 2007Farmer, December 31, 2007
Currrent Assets: Cost Market Current Liabilities Cost Market
Cash/checking acct. $5,000 $5,000 Account Payable 6,000 6,000
Marketable securities 1,000 2,200 Notes payable within 1 year 15,000 15,000
Inventories Current portion of term debt 28,000 28,000
Crops 40,000 40,000 Accured Interest 15,700 15,700
Livestock 52,000 52,000 Income taxes payable 8,000 8,000
Supplies 4,000 4,000 Current portion - deferred taxes 15,020 15,260
Accounts receivable 1,200 1,200 Other accrued expenses 900 900
Prepaid expenses 500 500 Total Current Liabilities $88,620 $88,860
Investment in growing crops 7,600 7,600
Other current assets 0 0 Noncurrent Liabiltiies Cost Market
Total Current Assets $111,300 $112,500
Notes payable
Machinery 20,000 20,000
Noncurrent Assets: Cost Market Breeding Livestock 40,000 40,000
Real estate debt 175,000 175,000
Machines and equipment 67,500 95,000 Noncurrent portion - deferred taxes ------ 45,000
Breeding livestock (purch.) 48,000 60,000 Total Noncurrent Liabilities $235,000 $280,000
Breeding livestock (raised) 12,000 24,000 Total Liabilities $323,620 $368,860
Buildings and improvments 27,000 50,000
Land 288,000 400,000 Owner Equity
Other noncurrent assets 0 0
Total Noncurrent Assets $442,500 $629,000 Contributed capital 50,000 50,000
Total Assets $553,800 $741,500 Retained earnings 180,180 180,180
Valuation adjustment ------- 142,460
Total Equity $230,180 $372,640
Total liabilities and owner equity $553,800 $741,500
Assets Liabilities
22. Balance Sheet ExampleBalance Sheet Example
• Assets: most differences show up in
valuation of non-current assets
• Liabilities: Little difference in liabilities
sections, other than deferred taxes
• Owner equity: valuation adjustment on
market-basis balance sheet accounts for
change in assets’ worth over time
because of changes in market conditions
for items of the non-current assets
23. Balance Sheet AnalysisBalance Sheet Analysis
• Liquidity measures: current ratio,
working capital
• Solvency measures: debt/asset
ratio, equity/asset ratio, debt/equity
ratio, net capital ratio
• Other measure: debt structure ratio
29. Summary of DPIM Farmer’sSummary of DPIM Farmer’s
Financial ConditionFinancial Condition
Liquidity
Current ratio 1.27
Working capital $23,640
Solvency:
Debt/asset ratio 0.50
Equity/asset ratio 0.50
Debt/equity ratio 0.99
Measure Market Ratio
30. Net Capital RatioNet Capital Ratio
Computation
sliabilitieTotal
assetsTotal
ratiocapitalNet =
( )valuemarket01.2
$368,860
$741,500
ratiocapitalNet ==
32. Statement of Owner EquityStatement of Owner Equity
The FFSC recommends that a
statement of owner equity be
part of
a complete set of financial
records.
The statement shows the
sources of
change in owner equity over the
33. Statement of Owner EquityStatement of Owner Equity
Owner equity, January 1, 2003 $344,490
Net farm income for 2003 47,900
Less adjustment for income taxes paid and payable (8,150)
Net after-tax farm income 39,750
Less increase in current portion -- deferred income taxes (1,600)
Owner withdrawals from farm business (36,000)
Nonfarm income contributed to farm business 9,500
Net owner withdrawals from farm business (26,500)
Other capital contributions to farm business 0
Other capital distributions from farm business 0
Increase in market value of farm assets 22,500
Less increase in noncurrent portion of deferred income taxes (6,000)
Net increase in valuation equity 16,500
Owner equity, December 31, 2003 $372,640
34. SummarySummary
A balance sheet shows the financial
position of a business at a point in
time.
An important consideration is the
method
used to value assets. Cost methods
reflect
the original investment value. Market
valuation reflects current collateral
values.
The FFSC recommends listing both
