Lesson 2: The Balance Sheet

Key Concepts

• Balance Sheet Components:
  • Assets: Resources owned by the company.
  • Liabilities: Amounts the company owes.
  • Equity: Owner's claim after liabilities.
• Transaction Analysis: How transactions affect the balance sheet.

Example: Nike's Balance Sheet

• Year-End Date: May 31, 2023
  • Seasonal year-end likely to align with sports seasons.
• Largest Asset: Inventory at $8.4 billion.
• Equity vs. Debt:
  • Long-term debt: $8.9 billion.
  • Shareholder's equity: $14 billion.
• Market Capitalization: $110 billion (much higher than accounting equity).
  • Due to historical cost accounting.

Definitions

• Assets: Economic resources that provide future benefits.
  • Examples: Cash, accounts receivable, inventory, property, plant, and equipment.
  • Current Assets: Expected to be converted to cash within a year.
  • Non-current Assets: Not expected to be converted to cash within a year.
• Liabilities: Future obligations from past events.
  • Examples: Accounts payable, wages payable, debt.
  • Current Liabilities: Due within a year.
  • Non-current Liabilities: Due after a year.
• Equity: Owner's claim to the assets after liabilities.
  • Comprised of contributed capital (common stock and additional paid-in capital) and retained earnings.
  • Retained Earnings: Net income not distributed as dividends.

Transaction Analysis

• Transaction: Economic event impacting an entity.
  • Must involve at least two accounts.
• Accounts: Grouping of financial activities into broad classifications like cash, receivables, inventory.
• Steps:
  1. Identify the accounts affected.
  2. Determine if the account is increasing or decreasing.
  3. Classify them as assets, liabilities, or equity.
• Duality of Effects: Assets must equal liabilities plus equity.

Journal Entries and T-Accounts

• Journal Entry:
  • Debits and credits: Debits are not inherently good or bad, nor are credits.
  • Debits go on the left, credits on the right of a T-account.
  • Example transactions: Borrowing money, purchasing inventory, receiving payments, issuing stock.
• T-Accounts:
  • Used to track activities and accumulate transactions.
  • Sum debits and credits to determine account balances.

Preparing a Balance Sheet

• Transaction analysis feeds into T-accounts.
• Balances in T-accounts are used to create the balance sheet.
• Example balance sheet preparation from transactions.

Review

• No inherent value in debits or credits; purely positional in the T-account.
• Debits increase assets; credits increase liabilities and equity.
• Importance of transaction analysis in forming accurate financial statements.