Hi.
Else, here.
And in this video, we'll be producing the balance sheet.
The balance sheet summarizes the assets owned,
the liabilities owed, and the equity invested by the owners.
This statement shows the financial health
of a business at a specific point in time.
In order to understand the balance sheet,
we first have to understand the elements that make up
this statement-- assets, liabilities, and equity,
also called shareholders' equity.
Each element has characteristics that define them.
When we record the activities of a business,
we use these characteristics to determine
if the transaction will affect that element or not.
Let's look at each element on the balance sheet
individually, starting with assets.
Assets have three characteristics.
Assets are owned, they provide future economic benefit,
and they are due to past events.
Let's go through each of these characteristics
and expand on them.
First, assets are owned.
For example, my cell phone is an asset because I own it.
Second, assets provide future economic benefit.
That means that the assets will be used either directly
or indirectly to help the business.
The last characteristic of assets
is that they are due to a past event.
That means that there was an event
in the past that transferred ownership of the asset
to the business.
So to summarize, everything that a business owns
is considered an asset, a resource obtained
through a past event that will benefit
the business in the future.
On the balance sheet, assets are divided into two categories--
current and long term.
Why?
Financial statements are all about communicating
useful information to decision makers.
By grouping assets based on their characteristics--
in this case, how fast they are used or converted into cash--
stakeholders obtain a better understanding of the business'
financial position and health.
Let's define those two categories of assets.
Current assets are any assets that
will be converted into cash, sold,
or consumed within one year.
A few of the more common accounts found in this grouping
are things like cash and prepaid expenses.
Long term assets are any assets that
do not meet the definition of a current asset.
These are resources that will be converted into cash,
sold, or used over a period of more than one year.
They're divided into four subcategories-- long term
investments, property, plant, and equipment,
intangible assets, and other assets.
In order to better understand the accounts that
go into current and long term assets,
I suggest you check out the financial statement elements
video, which lists, defines, and describes
all the different accounts under each category.
How do companies get their assets?
They often use liabilities, the next element
of financial reporting.
They take on debt in order to increase their assets.
Liabilities also have three characteristics
that define them.
Liabilities are owed.
They will be settled in the future.
And finally, liabilities are due to past events.
Again, let's go through each of these characteristics
individually.
First, liabilities are owed-- an obligation or debt.
Important also is that they are owed to third parties--
individuals or groups who are outside of the business.
A personal example of a liability
is the student loan you might owe as a debt to the bank.
Second, liabilities will be settled in the future.
How are they settled?
Through the giving up of either cash, goods, or services.
For instance, a student loan will
be settled through the payment of cash in the future,
but other obligations may be settled by providing a service
or delivering a good.
Third, liabilities are due to past events.
To summarize, everything that a company owes to a third party
is considered a liability-- an obligation due to a past event
that the business will settle in the future.
Like assets, liabilities are divided
into current and long term, again to provide information
to stakeholders so that they can make decisions.
Current liabilities are obligations that
will be settled in one year.
Current liabilities include accounts such as accounts
payable and unearned revenue.
Long term liabilities are debts which
are settled beyond one year.
Long term liabilities, unlike long term assets,
don't have any more subcategories.
All of the long term liabilities are simply listed together.
The accounts included in long term
almost always have the word payable as part of the account
name.
Again, to learn more, check out the financial statement
elements video, which lists, defines,
and describes all the different accounts under each category.
We've already defined the element equity
when you completed the statement of retained earnings.
As a reminder, equity is a financing by owners.
Recall that it is made up of contributed capital
and retained earnings.
It answers the question, what part of the business
is financed by the owners?
Similar to liabilities, the amount of equity
is owed to the owners by the business.
Let's do a quick check your understanding.
Remember to pause the video and answer before I answer for you.
The right to receive money in the future from a customer
is an asset called accounts receivable.
It's an asset because it has future benefit
for the business that will be converted into cash.
The right to collect cash in the future
is a legal right which is owned, and it is recorded
due to a past transaction.
Now that we understand the elements that make up
the balance sheet, we can look at an example of a balance
sheet.
Note that the statement is so large
that I've divided it into sections so
that you can see them better.
However, the balance sheet written out on paper
would show all these sections together,
one right after the other.
As always, the statement starts with the heading,
which must include the business name and the title
of the financial statement.
One change from previous statements-- the balance sheet
is at a point in time, not for a period of time.
Why?
Because every time a business has another transaction,
their financial position changes.
For example, if you have $10 in your pocket
and then you buy a Timmy's, your financial position has changed.
That's why the balance sheet is a snapshot.
One second of time--
the title of the statement reflects that.
Listed first on the balance sheet
are the assets with the heading assets.
Then there is a subheading called current assets.
There, you'll see the details of the current asset section.
Notice that the assets are listed in order of liquidity.
The faster the business can convert the assets into cash,
sell, or use them, the higher they are on the list.
For example, accounts receivable is listed before inventory
because the business is likely to collect
the cash from their customers before they
sell more inventory.
Note that assets which will be converted into cash
are always listed before assets which will be used or consumed.
Inventory can be sold for cash, but pre-paid insurance
will be used up over time.
So both the prepaid insurance and supplies are listed last.
Is the order of the items that will be used up over time
important?
Actually, no.
I could have listed supplies before prepaid insurance
and the statement would still be correct.
Next, there is a subtotal called total current assets.
Next, we move on to long term assets.
Remember that the long term assets are subdivided
into four different groupings.
The first is long term investments.
Note that each subcategory of long term assets
has its own heading and subtotal.
First is long term investments, here made up
of two accounts-- debt investments and equity
investments.
As noted, there is a heading and a subtotal called
total long term investments.
Next is property, plant, and equipment.
Here it is listed with the accumulated depreciation listed
separately for each subgroup.
Land does not have an associated accumulated depreciation
because land, unless under very special circumstances,
is not used up or consumed over time.
Remember that accumulated depreciation
is the total amount of the asset that has been used or consumed
since the asset was purchased.
Next, the total of all the intangibles
are provided as one line item.
Finally, other assets, which are every single long term
asset which does not fall into the other subcategories.
For instance, accounts receivable
that are outstanding for two years would be included here,
or two years of pre-paid rent would
be included in this catchall subcategory of long term
assets.
At the bottom of the asset section
are total assets, which includes both the current and long term
assets together.
Liabilities are next.
Recall that liabilities are divided
into current and long term, with current listed first.
This part of the balance sheet starts
with the heading liabilities and then current liabilities.
The current liabilities are listed
in order of how fast they will be paid or settled.
The faster they will be settled, the higher
they appear on the listing.
Notice that current liabilities includes an account
called current portion of note payable.
This amount is a total note payable, basically
a loan, that will be paid within the upcoming year.
It is part of current liabilities
because it meets the definition of a current liability--
due within one year.
A total of all the current liabilities is then provided.
Long term liabilities have the same structure-- a heading,
a list of accounts which make up the subcategory, and then
a total.
Remember the current portion of the note payable?
The long term portion which is due beyond the one year period
is listed under long term.
The total note payable is the current portion
plus the long term portion together.
The liability section closes with the total
for all the liabilities, current and long term.
It should be noted that if a subsection of liabilities
has only one account, there is no need for a subtotal.
For example, if long-term liabilities only
had one account called note payable,
then there would be no long term liabilities total needed.
The amount of notes payable would simply
be listed by itself with no subtotal
but still with a heading.
Next is a shareholders' equity section
with the heading shareholders' equity.
Details of the split between contributed capital
and retained earnings is provided.
Note that the contributed capital is always listed first,
followed by retained earnings.
A subtotal of the shareholders' equity section
is provided before a final total of all liabilities
plus shareholders' equity.
That completes the balance sheet.
Notice something very important.
Total assets are equal to total liabilities
plus shareholders' equity.
This is called the accounting equation.
This equation shows that economic resources or assets
are financed either through debt or liabilities or equity
from owners.
In the balance sheet, assets always
equal liabilities plus shareholders' equity.
Pause the video in order to answer the following check
your understanding question.
The balance sheet would not include which
of the following accounts?
The answer is not A. Office supplies
are owned and have future benefit for the business.
So they will be recorded as assets.
The answer is not B because unearned revenue represents
the goods or services owed to customers
and is therefore on the balance sheet as a liability.
The answer is not C either because capital contributions
are the direct investment by owners
which appear on the balance sheet as part of equity.
The answer is not E because prepaid insurance is owned
and will provide benefit in the future.
So it's recorded as an asset.
The correct answer is D because customer
lists the business have developed themselves are not
listed on the balance sheet because they are not
due to a financial transaction with an outside party.
As such, they would be valuable to the business,
but they would never be listed on their balance sheet.
So what questions does a balance sheet answer?
For investors, it shows that the business
could pay its current and long term debts as they come due.
For creditors, it indicates that there's
enough assets to operate.
If the business can't operate, is there enough assets
to cover outstanding debts?
Does the business have enough cash
to pay its debts as they come due?
Considering current debt levels, should we lend more money?
For both investors and lenders, it answers the question,
does the business use debt or equity financing?
The balance sheet is not the last financial statement
we're going to complete.
The amount of cash from the balance sheet
is used in conjunction with the income statement
to create the statement of cash flows, which
is the topic of our next video.