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CHAPTER 2 - CHAPTER 2 A Further Look at Financial...

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CHAPTER 2 A Further Look at Financial Statements Study Objective 1 - Identify the Sections of a Classified Balance Sheet In a classified balance sheet companies often group similar assets and similar liabilities together as they have similar economic characteristics. The groupings help users to determine (1) whether the company has enough assets to pay its debts and (2) the claims of short-and long- term creditors on the company's total assets. A classified balance sheet generally contains the following standard classifications: Current Assets § Assets that are expected to be converted to cash or used in the business within a short period of time, usually one year § Examples of current assets: cash, short-term investments (which include marketable securities), receivables (accounts receivable and notes receivable), inventories, supplies, and prepaid expenses (rent, insurance, advertising). § On the balance sheet, current assets are listed in the order in which they are expected to be converted into cash (order of liquidity). Long-Term Investments § Assets that can be converted into cash, but whose conversion is not expected within one year. § Assets not intended for use within the business. § Examples are investments of stocks and bonds of other corporations. Example: A homebuilder has the following assets: (1) lots in a subdivision that are ready for sale to buyers; (2) land on which the corporate office building sits; and (3) land several miles north of town on which it plans a new subdivision in 5 years. Ask students where each of these parcels of land would go on a classified balance sheet. This shows that the classification depends on the use by the company. Property, Plant, and Equipment § Assets with relatively long useful lives. § Assets used in operating the business. § Examples include land, buildings, machinery, delivery equipment, and furniture and fixtures. § These are listed in the order of permanency. § Record these assets at cost and depreciate them (except land) over their useful lives. The full purchase price is not expensed in the year of purchase because the assets will be used for more than one accounting period. § Depreciation is the practice of allocating the cost of assets to a number of years. § Depreciation expense is the amount of the allocation for one accounting period. Accumulated depreciation is the total amount of depreciation that has been expensed since the asset was placed in service.
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§ Cost less accumulated depreciation is reported on the balance sheet. Depreciation is not a valuation of assets. It is the allocation of their cost over the periods in which they will benefit the business. Many students believe the balance sheet shows the value of the business. Accounting (with a few exceptions that are covered in later chapters) records cost – not value.
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