Classify each item as an asset liability or stockholders equity

The Classified Balance Sheet

LEARNING OBJECTIVE 6 Identify the sections of a classified balance sheet.

The balance sheet presents a snapshot of a company's financial position at a point in time. To improve users' understanding of a company's financial position, companies often use a classified balance sheet. A classified balance sheet groups together similar assets and similar liabilities, using a number of standard classifications and sections. This is useful because items within a group have similar economic characteristics. A classified balance sheet generally contains the standard classifications listed in Illustration 4-17.

Illustration 4-17 Standard balance sheet classifications

These groupings help financial statement readers determine such things as (1) whether the company has enough assets to pay its debts as they come due, and (2) the claims of short- and long-term creditors on the company's total assets. Many of these groupings can be seen in the balance sheet of Franklin Corporation shown in Illustration 4-18 below. In the sections that follow, we explain each of these groupings.

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Illustration 4-18 Classified balance sheet

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Helpful Hint

.

Current Assets Current assets are assets that a company expects to convert to cash or use up within one year or its operating cycle, whichever is longer. In Illustration 4-18, Franklin Corporation had current assets of $22,100. For most businesses, the cutoff for classification as current assets is one year from the balance sheet date. For example, accounts receivable are current assets because the company will collect them and convert them to cash within one year. Supplies is a current asset because the company expects to use it up in operations within one year. Some companies use a period longer than one year to classify assets and liabilities as current because they have an operating cycle longer than one year. The operating cycle of a company is the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers. For most businesses this cycle takes less than a year, so they use a one-year cutoff. But, for some businesses, such as vineyards or airplane manufacturers, this period may be longer than a year. Except where noted, we will assume that companies use one year to determine whether an asset or liability is current or long-term. Common types of current assets are (1) cash, (2) short-term investments (such as short-term U.S. government securities), (3) receivables (notes receivable, accounts receivable, and interest receivable), (4) inventories, and (5) prepaid expenses (supplies and insurance). On the balance sheet, companies usually list these items in the order in which they expect to convert them into cash. Illustration 4-19 presents the current assets of Southwest Airlines Co.

Illustration 4-19 Current assets section Lowell Sannes/iStockphoto.

As explained later in the chapter, a company's current assets are important in assessing its short-term debt-paying ability.

Long-Term Investments

Alternative Terminology Long-term investments are often referred to simply as investments.

Long-term investments are generally, (1) investments in stocks and bonds of other companies that are normally held for many years, and (2) long-term assets such as land or buildings that a company is not currently using in its

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operating activities. In Illustration 4-18, Franklin Corporation reported total long-term investments of $7,200 on its balance sheet. Yahoo! Inc. reported long-term investments in its balance sheet as shown in Illustration 4-20.

Illustration 4-20 Long-term investments section Gunay Mutlu/iStockphoto.

Property, Plant, and Equipment Property, plant, and equipment are assets with relatively long useful lives that a company is currently using in operating the business. This category (sometimes called fixed assets) includes land, buildings, machinery and equipment, delivery equipment, and furniture. In Illustration 4-18, Franklin Corporation reported property, plant, and equipment of $29,000.

International Note Recently, China adopted International Financial Reporting Standards (IFRS). This was done in an effort to reduce fraud and increase investor confidence in financial reports. Under these standards, many items, such as property, plant, and equipment, may be reported at current fair values, rather than historical cost.

Depreciation is the practice of allocating the cost of assets to a number of years. Companies do this by systematically assigning a portion of an asset's cost as an expense each year (rather than expensing the full purchase price in the year of purchase). The assets that the company depreciates are reported on the balance sheet at cost less accumulated depreciation. The accumulated depreciation account shows the total amount of depreciation that the company has expensed thus far in the asset's life. In Illustration 4-18, Franklin Corporation reported accumulated depreciation of $5,000. Illustration 4-21 presents the property, plant, and equipment of Cooper Tire & Rubber Company.

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Illustration 4-21 Property, plant, and equipment section Denis Vorobyev/iStockphoto.

Intangible Assets

Helpful Hint Sometimes intangible assets are reported under a broader heading called “Other assets.”

Many companies have long-lived assets that do not have physical substance yet often are very valuable. We call these assets intangible assets. One common intangible asset is goodwill. Others include patents, copyrights, and trademarks or trade names that give the company exclusive right of use for a specified period of time. In Illustration 4-18, Franklin Corporation reported intangible assets of $3,100. Illustration 4-22 shows the intangible assets of media giant Time Warner, Inc.

Illustration 4-22 Intangible assets section Nikki Ward/iStockphoto.

PEOPLE, PLANET, AND PROFIT INSIGHT

Regaining Goodwill

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Gehringj/iStockphoto.

After falling to unforeseen lows amidst scandals, recalls, and economic crises, the American public's positive perception of the reputation of corporate America is on the rise. Overall corporate reputation is experiencing rehabilitation as the American public gives high marks overall to corporate America, specific industries, and the largest number of individual companies in a dozen years. This is according to the findings of the 2011 Harris Interactive RQ Study, which measures the reputations of the 60 most visible companies in the U.S. The survey focuses on six reputational dimensions that influence reputation and consumer behavior. The six dimensions, along with the five corporations that ranked highest within each, are as follows.

• Social Responsibility: (1) Whole Foods Market, (2) Johnson & Johnson, (3) Google, (4) The Walt Disney Company, (5) Procter & Gamble Co.

• Emotional Appeal: (1) Johnson & Johnson, (2) amazon.com, (3) UPS, (4) General Mills, (5) Kraft Foods • Financial Performance: (1) Google, (2) Berkshire Hathaway, (3) Apple, (4) Intel, (5) The Walt Disney

Company • Products and Services: (1) Intel Corporation, (2) 3M Company, (3) Johnson & Johnson, (4) Google, (5)

Procter & Gamble Co. Name two industries today which are probably rated low on the reputational characteristics of “being trusted” and “having high ethical standards.” Answer:

Two possible industries are financial companies (Goldman Sachs or AIG) or oil companies (BP).

Source: www.harrisinteractive.com.

DO IT! Asset Section of Classified Balance Sheet Baxter Hoffman recently received the following information related to Hoffman Company's December 31, 2014, balance sheet.

Prepaid insurance $ 2,300 Inventory $3,400

Cash 800 Accumulated depreciation—equipment 2,700

Equipment 10,700 Accounts receivable 1,100

Prepare the asset section of Hoffman Company's classified balance sheet.

Action Plan

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✓ Present current assets first. Current assets are cash and other resources that the company expects to convert to cash or use up within one year.

✓ Present current assets in the order in which the company expects to convert them into cash. ✓ Subtract accumulated depreciation—equipment from equipment to determine net equipment.

Solution

Assets

Current assets

Cash $  800

Accounts receivable 1,100

Inventory 3,400

Prepaid insurance 2,300

Total current assets $  7,600

Equipment 10,700

Less: Accumulated depreciation—equipment 2,700 8,000

Total assets $15,600

Related exercise material: BE4-10 and 4-3.

Current Liabilities

Ethics Note

A company that has more current assets than current liabilities can increase the ratio of current assets to current liabilities by using cash to pay off some current liabilities. This gives the appearance of being more liquid. Do you think this move is ethical?

In the liabilities and stockholders' equity section of the balance sheet, the first grouping is current liabilities. Current liabilities are obligations that the company is to pay within the coming year or its operating cycle, whichever is longer. Common examples are accounts payable, wages payable, bank loans payable, interest payable, and taxes payable. Also included as current liabilities are current maturities of long-term obligations—payments to be made within the next year on long-term obligations. In Illustration 4-18, Franklin Corporation reported five different types of current liabilities, for a total of $16,050.

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Within the current liabilities section, companies usually list notes payable first, followed by accounts payable. Other items then follow in the order of their magnitude. In your homework, you should present notes payable first, followed by accounts payable, and then other liabilities in order of magnitude. Illustration 4-23 shows the current liabilities section adapted from the balance sheet of Marcus Corporation.

Illustration 4-23 Current liabilities section Brentmelissa/iStockphoto.

Users of financial statements look closely at the relationship between current assets and current liabilities. This relationship is important in evaluating a company's liquidity—its ability to pay obligations expected to be due within the next year. When current assets exceed current liabilities at the balance sheet date, the likelihood for paying the liabilities is favorable. When the reverse is true, short-term creditors may not be paid, and the company may ultimately be forced into bankruptcy.

ACCOUNTING ACROSS THE ORGANIZATION

Can a Company Be Too Liquid?

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Jorge Salcedo/iStockphoto.

There actually is a point where a company can be too liquid—that is, it can have too much working capital (current assets less current liabilities). While it is important to be liquid enough to be able to pay short-term bills as they come due, a company does not want to tie up its cash in extra inventory or receivables that are not earning the company money. By one estimate from the REL Consultancy Group, the thousand largest U.S. companies have on their books cumulative excess working capital of $764 billion. Based on this figure, companies could have reduced debt by 36% or increased net income by 9%. Given that managers throughout a company are interested in improving profitability, it is clear that they should have an eye toward managing working capital. They need to aim for a “Goldilocks solution”—not too much, not too little, but just right.

What can various company managers do to ensure that working capital is managed efficiently to maximize net income? Answer:

Marketing and sales managers must understand that by extending generous repayment terms, they are expanding the company's receivables balance and slowing the company's cash flow. Production managers must strive to minimize the amount of excess inventory on hand. Managers must coordinate efforts to speed up the collection of receivables, while also ensuring that the company pays its payables on time but never too early.

Source: K. Richardson, “Companies Fall Behind in Cash Management,” Wall Street Journal (June 19, 2007).

Long-Term Liabilities Long-term liabilities are obligations that a company expects to pay after one year. Liabilities in this category include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. Many companies report long-term debt maturing after one year as a single amount in the balance sheet and show the details of the debt in notes that accompany the financial statements. Others list the various types of long-term liabilities. In Illustration 4-18, Franklin Corporation reported long-term liabilities of $11,300. In your homework, list long-term liabilities in the order of their magnitude. Illustration 4-24 shows the long-term liabilities that The Procter & Gamble Company reported in its balance sheet.

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Illustration 4-24 Long-term liabilities section Vladislav Gurfinkel/iStockphoto.

Stockholders' (Owners') Equity The content of the owners' equity section varies with the form of business organization. In a proprietorship, there is one capital account. In a partnership, there is a capital account for each partner. Corporations divide owners' equity into two accounts—Common Stock (sometimes referred to as Capital Stock) and Retained Earnings. Corporations record stockholders' investments in the company by debiting an asset account and crediting the Common Stock account. They record in the Retained Earnings account income retained for use in the business. Corporations combine the Common Stock and Retained Earnings accounts and report them on the balance sheet as stockholders' equity. (We'll learn more about these corporation accounts in later chapters.) Nordstrom, Inc. recently reported its stockholders' equity section as follows.

Illustration 4-25 Stockholders' equity section iStockphoto.

DO IT! Balance Sheet Classifications The following accounts were taken from the financial statements of Callahan Company.

________ Salaries and wages payable ________ Service revenue ________ Interest payable ________ Goodwill ________ Short-term investments ________ Mortgage payable (due in 3 years) ________ Investment in real estate ________ Equipment ________ Accumulated depreciation—equipment ________ Depreciation expense ________ Common stock ________ Unearned service revenue

Match each of the following accounts to its proper balance sheet classification, shown below. If the item would not appear on a balance sheet, use “NA.”

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Current assets (CA) Long-term investments (LTI) Property, plant, and equipment (PPE) Intangible assets (IA) Current liabilities (CL) Long-term liabilities (LTL) Stockholders' equity (SE)

Action Plan ✓ Analyze whether each financial statement item is an asset, liability, or stockholders' equity. ✓ Determine if asset and liability items are short-term or long-term.

Solution _CL_ Salaries and wages payable _NA_ Service revenue _CL_ Interest payable _IA_ Goodwill _CA_ Short-term investments _LTL_ Mortgage payable (due in 3 years) _LTI_ Investment in real estate _PPE_ Equipment _PPE_ Accumulated depreciation—equipment _NA_ Depreciation expense _SE_ Common stock _CL_ Unearned service revenue

Related exercise material: BE4-11, E4-14, E4-15, E4-16, E4-17, and 4-4.

Copyright © 2012 John Wiley & Sons, Inc. All rights reserved.

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