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Print this chapterThe Balance Sheet
This lesson will introduce the balance sheet, a representation of a firm's financial position at a single point in time. The balance sheet is one of the four major financial statements. You will be able to identify assets, liability, and shareholder's equity, and learn how to compute the balance sheet equation. You will also be able to create a balance sheet.
The three limitations to balance sheets are assets being recorded at historical cost, use of estimates, and the omission of valuable non-monetary assets.
LEARNING OBJECTIVES
- Understand the limitations of the balance sheet.
- Differentiate the balance sheet from all other financial statements
KEY POINTS
- Balance sheetsdo not show true value ofassets. Historical cost is criticized for its inaccuracy since it may not reflect current marketvaluation.
- Some of thecurrent assetsare valued on an estimated basis, so the balance sheet is not in a position to reflect the true financial position of the business.
- The balance sheet can not reflect those assets which cannot be expressed in monetary terms, such as skill, intelligence, honesty, and loyalty of workers.
TERMS
- carrying value
In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or Impairment costs made against the asset.
- Fixed assets
Fixed assets, also known as non-current assets or property, plant, and equipment (PP&E), is a term used in accounting for assets and property that cannot easily be converted into cash. This can be compared with current assets, such as cash or bank accounts, which are described as liquid assets. In most cases, only tangible assets are referred to as fixed.
Limitations of the Balance Sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, businesspartnership, corporation, or other business organization, such as an LLC or an LLP. Assets, liabilitiesand ownershipequityare listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basicfinancial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year. There are three primary limitations to balance sheets, including the fact that they are recorded at historical cost, the use of estimates, and the omission of valuable things, such as intelligence.
Fixed assetsare shown in the balance sheet at historical cost lessdepreciationup to date. Depreciation affects thecarrying valueof an asset on the balance sheet. The historical cost will equal the carrying value only if there has been no change recorded in the value of the asset since acquisition. Therefore, the balance sheet does not show true value of assets. Historical cost is criticized for its inaccuracy since it may not reflect current market valuation.
Four depreciation methods
Different methods of depreciation affect the carrying value of an asset on balance sheets.
Some of the current assets are valued on estimated basis, so the balance sheet is not in a position to reflect the true financial position of the business.Intangible assetslikegoodwillare shown in the balance sheet at imaginary figures, which may bear no relationship to themarket value. The International Accounting Standards Board (IASB) offers some guidance (IAS 38) as to how intangible assets should be accounted for in financial statements. In general, legal intangibles that are developed internally are not recognized, and legal intangibles that are purchased from third parties are recognized. Therefore, there is a disconnect–goodwill from acquisitions can be booked, since it is derived from a market or purchase valuation. However, similar internal spending cannot be booked, although it will be recognized byinvestorswho compare a company's market value with its book value.
Finally, the balance sheet can not reflect those assets which cannot be expressed in monetary terms, such as skill, intelligence, honesty, and loyalty of workers.
