Also known as the statement of financial position, the purpose of Balance Sheet is to help the investors or other interested groups in understanding the financial position of the company. It is an expression of all the assets that the company owns, all the liabilities of the company and the capital that the owner’s have pooled into the company, in accounting terms. The entire concept of Balance Sheet is based upon the formula known as The Accounting Equation (Smith, 2007):
Assets = Liabilities + Shareholder Equity
The transactions are recorded in the Balance Sheet on the basis of a double entry system. Any transaction would have a dual effect on the balance sheet, either it would have an equal effect on both sides of the equation, or it would have an offsetting effect on the same side of the Balance Sheet. Whatever the case is, the Balance Sheet always remains balanced.
Valuation of the assets and liabilities can be done according to GAAP or IFRS, as well. However, there are some major differences between the valuation standards of both these set of principles, such as:
- GAAP is more flexible in the valuation of inventory, and allows all the popular methods for the valuation purposes, such as, FIFO, LIFO, weighted average etc. However, IFRS does not allow the companies to use LIFO for the valuation of their inventory. If a company uses LIFO, under IFRS it would to revalue its inventory when it wants to publish its financial reports under GAAP (Sulivan, 2011).
- Under GAAP companies are allowed to write down their assets, but they cannot write up their assets to match the fair market value. However, under IFRS both write downs and write ups are allowed. This enables a company to revalue its Property Plant and Equipment to the fair market value.
- Research and Development cost are huge for many companies, GAAP classifies these as expenses and they have to be expensed out. However, IFRS capitalization of R&D costs, which can significantly increase the size of the Balance Sheet.
Assets and Expenses
The only similarity between as asset and expense is that they both represent an initial outflow of cash, other than that they are quite different. Assets are the items on the Balance Sheet that represent something owned by the company. Assets represent a resource owned by the company, and they are expected to generate future cash inflows (Edwards & Hermanson, 2007). Expenses on the other hand are mentioned in the Income Statement and not the Balance Sheet; they do not represent any resource owned by the company. Expenses represent the economic cost that any company has to incur in order to earn revenue or profits, expenses are known as expired costs, as well.
Current and Long-Term Assets
Current assets are the assets which are expected to be very liquid in nature. Usually, they are expected to convert into cash in one year or one operating cycle of the company. Generally, cash, accounts receivables, inventory, marketable securities and prepaid expenses are classified as typical current assets. Long-term assets are, to some extent, opposite to the current assets, they are not very liquid and very less likely to convert into cash in the near future on a fair market value. Also known as non-current assets, they have to be capitalized rather than expensed. It means that their entire cost is not expensed out in one accounting period in which they are purchased; rather they are kept on the Balance Sheet and the cost is divided over several accounting periods.
Current Liabilities and Long-term liabilities
The difference between current and long-term liabilities is somewhat the same as the difference between current and long-term assets. Current liabilities are the ones that due in no longer than one year or one operating cycle of the company (Smith, 2007). On the other hand, the long-term liabilities are the ones which do not come due within one year or one operating cycle of the company. Typical current liabilities include: short-term debt, Accounts Payables and accrued liabilities etc, and a company’s liabilities for lease or bond repayments are examples of long-term liabilities. As a general rule, current liabilities are financed by current assets, and long-term liabilities are financed by long-term assets.
Examples of each category from Apple’s Balance Sheet:
|Account||Example 1||Example 2|
|Asset||Land||Property Plant and Equipment|
|Expense||Interest expense||Operating expense|
|Current Asset||Cash and cash equivalents||Inventory|
|Current Liability||Accounts Payable||Short-term debt|
|Long-term asset||Long-term investments||Goodwill|
|Long-term liability||Long-term debt||Minority interest|
All public companies are regarded as “on-going concern”, which means that they are expected to continue their operations indefinitely. This means that the companies need to finance their own operations, there are several different sources of financing, and retained earnings are one of them. Retained earnings is an account in which the company keeps a potion of the profit it makes, and these earnings, which are retained, are reinvested in the business for growth purposes. The higher is the income of the company, probably higher will be the retained earnings because the company would have more money to retain, and if the company incurs losses then it books losses in this account, which basically means that the level of retained earnings has decreased. Dividends also greatly affect the Retained Earnings, because the profits have to be divided amongst dividends and retained earnings. If larger amounts of money are distributed as dividends, lesser amount of money would be let for retained earnings.
Apple’s retained earnings increased from $ 37,169,000,000 in 2010, to $ 62,841,000,000 in 2011. This shows that Apple made huge profits in the last year, out of which it reinvested $25,672,000,000 in the company and distributed the rest as dividends.
Differences between Philips’ and Apple’s Balance Sheet
Following are the some of the differences between the two Balance Sheets:
- The Balance Sheet dates are different, Apple’s closing date is in September, whereas, Philips’ closing date is 31st December.
- Apple has no treasury stock in their Balance Sheet, whereas, Philips has $(2,194,000,000) (Koninklijke Philips Electronics, 2011) worth of treasury stock.
- Apple has no debt in their Balance Sheet (Apple Inc., 2011), whereas, Philips has $4,255,000,000 of long-term debt.
Philips clearly has lots of debt, and surprisingly Apple has no short-term or long-term debt, at all.
Apple clearly is the larger company here. Different criteria can be used to judge the size of the company, for instance sales, number of employees, geographical representation etc, but since this essay is about Balance Sheet, I have used the Balance Sheet size as the criteria. Apple has a total of $116,371,000,000 (Apple Inc., 2011) in assets, where as the total assets of Philips are $37,603,000,000 (Koninklijke Philips Electronics, 2011), this shows a huge difference in the size of the two companies.
Apple Inc. (2011). Annual reports. New York: Apple Inc. Print.
Edwards, J., & Hermanson, R. (2007). Accounting Principles: A Business Perspective. New York: Prentice Hall. Print.
Koninklijke Philips Electronics. (2011). Annual Reports. New York: Koninklijke Philips Electronics. Print.
Smith, J. (2007). Handbook Of Management Accounting (4th ed.). Oxford: CIMA publication. Print.
Sulivan, R. (2011). Financial Reporting And Analysis. Kansas: CFA institute. Print.