Accounting Chapter 2: Balance Sheet Assets

Chapter 2: Balance Sheet: Asset

• This chapter examines assets on a balance sheet.
• It defines assets as items that provide future economic benefits.
• Assets must be owned or controlled by the company and must arise from a past transaction or event.
• Assets are categorized as current or non-current.

Different Current Assets

• Cash: Currency and bank deposits.
• Cash equivalents: Investments with maturities of 90 days or less.
• Short-term investments: Marketable securities expected to be sold within a year.
• Accounts receivables (net): Amounts due from customers from sales on credit (after deducting uncollectible amounts).
• Inventories: Goods purchased or produced for sale to customers.
• Prepaid expenses: Costs paid in advance for rent, insurance, advertising, and other services.

Analyzing Cash and Cash Equivalents

• "Cash and Cash equivalents" can be liquidated immediately.
• Crucial for determining operating cash needed to run the business.
• Excess cash is the amount above operating cash.
• Operating cash is usually around one percent of total sales.

Analyzing Inventory

• Inventory represents goods purchased or produced for sale.
• Ending inventory (closing stock) is calculated by multiplying quantity by value.
• Inventory valuation methods: FIFO, LIFO, and Weighted Average.
• FIFO (First-In, First-Out) assumes first goods in are first goods sold.
• LIFO (Last-In, First-Out) assumes last goods in are first goods sold (not permitted in IFRS).
• Inventory turnover and days inventory outstanding (DIO) are metrics for analyzing inventory management.
• A lower DIO is preferable, as it indicates faster inventory turnover and better cash flow.

Analyzing Accounts Receivables

• Accounts receivable represents amounts due from customers arising from sales on credit.
• Reported on balance sheets net of the allowance for doubtful (uncollectible) accounts.
• Aging analysis helps to estimate uncollectible accounts.
• Accounts receivable turnover and days sales outstanding (DSO) are metrics for analyzing credit management.
• A higher degree of accounts receivable growth compared to sales could indicate that the company is excessively granting credit or that credit quality is deteriorating.

Different Non-Current Assets

• Property, plant, and equipment (PPE): Land, buildings, and equipment (after deducting accumulated depreciation).
• Long-term investments: Investments the company does not intend to sell within a year.
• Intangible assets: Assets without physical substance (e.g., patents, trademarks, licenses).
• Goodwill: Residual of the purchase price when a company engages in mergers and acquisitions.

Analyzing Property, Plant, and Equipment (PPE)

• PPE turnover measures productivity and efficiency.
• A higher turnover means the company is using its investment effectively.
• Average useful life is derived using the equation (Decreciable asset costs + Decreciable asset costs previous period) / 2 all divided by depreciation expense.
• Percent used up measures the proportion of a company's depreciable assets that have been used in their useful lives.

Analyzing Intangible Assets

• Intangible assets lack physical substance but provide long-term economic benefits.
• Internally generated intangible assets are usually expensed.
• Externally bought intangible assets can be capitalized and amortized.
• Common types include marketing-related assets, customer-related assets, artistic assets, contract-based assets, and technology-based assets.

Analyzing Goodwill

• Goodwill is the difference between the purchase price and the net asset value of an acquired company.
• Goodwill is subject to annual impairment testing.
• Companies account for M&A transactions by recognizing all the assets/liabilities of the target.
• Goodwill is computed by subtracting the net assets from the purchase price and is a component of the cost to generate future cash flows.

Common Size Analysis

• Common size analysis expresses balance sheet and income statement items as a percentage of a base amount (e.g., total assets or total sales, respectively).
• This facilitates cross-sectional comparisons (over a time period or comparing with other companies).
• Trend analysis compares the same item across time, showcasing changes in position.