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The accounting balance sheet is one of the major financial statements used by accountants and business owners. The other major financial statements are the income statement, statement of cash flows, and statement of stockholders’ equity. The balance sheet presents a company’s financial position at the end of a specified date. Because the balance sheet informs the reader of a company’s financial position, as well as what it owes to other parties, this is valuable information.
Assets are the resources of the company, and have future economic value that can be measured in dollars. Assets commonly cover cash on hand, accounts receivable, buildings and equipment, but also include costs paid in advance such as prepaid advertising, prepaid insurance, prepaid legal fees, and prepaid rent. Examples of asset accounts that are reported on the balance sheet may include, but are not limited to:
• Petty Cash
• Temporary Investments
• Accounts Receivable
• Prepaid Insurance
• Land & Improvements
• Bond Issue Costs
• Allowance for Doubtful Accounts
• Accumulated Depreciation – Land & Buildings
• Accumulated Depreciation – Equipment
• Accumulated Depletion
Liabilities are obligations of the company, amounts owed to creditors for a past transaction, or payables such as wages, rents, or taxes. Along with owner’s equity, liabilities can be thought of as a source of the company’s assets, as well as a claim against a company’s assets. Liabilities may also include amounts received in advance for future services, reported as Unearned Revenues or Customer Deposits. Typical liabilities include the following:
• Notes Payable
• Accounts Payable
• Salaries Payable
• Wages Payable
• Interest Payable
• Other Accrued Expenses Payable
• Income Taxes Payable
• Customer Deposits
• Warranty Liability
• Lawsuits Payable
• Unearned Revenues
• Bonds Payable
• Discount on Notes Payable
• Discount on Bonds Payable
A company’s commitment to purchase goods may be legally binding but is not considered a liability on the balance sheet until actual services or goods have been received. Commitments must be disclosed in the notes appending the balance sheet. Similarly, the leasing of an asset may appear to be a rental cost, but in substance, it may involve an agreement to purchase the asset and finance it through monthly payments. Therefore, accountants must look past outward appearances, and focus on the substance of business transactions.
Contingent Liabilities include the warranty of a company’s products, the guarantee of another party’s loan, and lawsuits filed against a company. If the contingent loss is highly probable, and the amount of the loss can be estimated, the company needs to record a liability on its balance sheet and a loss on its income statement. However, if the contingent loss is only a remote possibility, no liability or loss is recorded and there is no need at that time to include the matter in notes to the financial statements.
The income statement is often referred to as a profit and loss statement (P&L;), statement of operations, or statement of income. The income statement is important because it shows the profitability of a company during the time interval specified in its heading. The income statement shows revenues, expenses, gains, and losses, but it does not include cash receipts nor cash disbursements. This information is collected in a Statement of Cash Flows.
Revenues from primary activities are often referred to as operating revenues. The primary activities of a business are purchasing merchandise or raw materials and selling products, referred to as sales revenues or sales. The primary activities of a company that provides services involve selling expertise to clients. For companies providing services, the revenues from their primary services are referred to as service revenues or fees. It is common in business to extend a modest amount of time to repeat customers to pay for purchases. For example, if a retailer gives customers 30 days to pay, revenues occur (and are reported) when the merchandise is sold to the buyer, not when the cash is received 30 days later.
Non-operating Revenues are amounts a business earns outside of purchasing and selling goods and services. For example, when a retail business earns interest on some of its idle cash, or sells an commodity investment for a capital gain, these revenues result from an activity outside of buying and selling merchandise. As a result the revenues are reported on the income statement separate from its primary activity of sales or service income.
Expenses involved in primary activities are expenses that are incurred in order to earn normal operating revenues. Under the accrual basis of accounting, the cost of goods sold and expenses are matched to sales and the accounting period when they are used, not the period in which they are paid. Because of the cost principle and inflation, the expenses shown on the income statement reflect costs that may have different present values. An accountant, though, is not allowed the luxury of waiting until things are known with certainty, so in order to properly account for revenues when they are earned, and expenses when they are incurred, accountants must often use cost estimates.
Secondary Expenses are referred to as non-operating expenses. For example, interest expense is a non-operating expense because it involves the finance function of the business, rather than the primary activities of buying, producing and selling merchandise. Losses such as the loss from the sale of long-term assets, or the loss on lawsuits result from a transaction that is outside of a business’s primary activities. A loss is reported as the net of two amounts: the amount listed for the item on the company’s books (book value) minus the proceeds received from the sale. A loss occurs when the proceeds are less than the original book value.
Net Income occurs when the net amount of revenues and gains minus expenses and losses is positive, the bottom line of the company’s performance. If the net amount is negative, there is a net loss. A company’s ability to operate profitably is paramount to both lenders and investors, company management, labor unions, and government regulators.