174 Chapter 5 The Work Sheet and Classified Financial Statements

*3 The purpose of financial statements is to provide financial information about a com­ pany to owners, management, , and government. By classifying items on the statements into special categories, it is possible to provide more information and to provide it in a way which is more easily interpreted.

Classified In Figure 5-6 in the previous unit, information is provided in the classified balance sheet to answer the following questions: • Which debts must be paid within a year? • Is there sufficient (or ) on hand to pay debts? • Which debts must be paid in future years? Look at Figute 5-6 and answer the preceding questions.

Assets and Liabilities The balance sheet of Gold's Gym illustrated in Figure 5-6 includes the standard classifications usually found on balance sheets. The assets are divided into two main groups: current and [txed. The liabilities are divided into two groups: current and long-term.

Current assets are Current Assets listed in order of Assets which are converted into cash in the ordinary course of business, usually liquidity. within one year, are called current assets. The list that follows provides some examples and the order in which current assets usually appear. They are listed in order of liquid­ Liquidity order is ity, that is, the order in which assets may be converted into cash. the order in which assets may be con­ verted into cash. Current Assets Cash Government Bonds Marketable Securities Accounts Receivable Merchandise Inventory Prepaid E2'penses ·

Government ~onds and Marketable Securities are easily converted into cash. For that reason, they are placed immediately after Cash in the current assets section of the classified balance sheet. Accounts Receivable, debts which most customers pay within 30 days, come next. The Merchandise Merchandise Inventory is an account used to record the value of merchan­ Inventory account records the value of dise on hand for sale to customers. When the merchandise is sold, cash will be even­ merchandise on hand tually received for it. For that reason, Merchandise Inventory is listed after Accounts for sale to customers. Receivable. Unit 10 Classified Financial Statements 175

Prepaid are items such as Prepaid Rent and Prepaid Insurance. They repre­ Prepaid Expenses sent the value of insurance policies owned by the company and rental leases for are pay­ which payment has been made. Although they are not generally converted into cash ments made in advance. in the normal operations of the business, they could be, if necessary. For example, many insurance policies have a cash value. A company in need of cash could "cash in" an insurance policy. Prepaid Expenses are listed after Cash, Government Bonds, Marketable Securities, Accounts Receivable, and Merchandise Inventory on the balance sheet.

Fixed Assets Fixed assets are assets such as land, buildings, equipment, and trucks that are used in operating the business and which have a long life. This section of the balance sheet may also be titled "plant and equipment." The fixed assets that have the longest life are generally listed frrst.

Fixed Assets Land Building Equipment Delivery Trucks

Fixed assets are recorded using the price at which they were purchased (cost prin­ ciple). This is a standard principle used by all .

Current Liabilities The term current liabilities generally refers to liabilities that must be paid within Current liabilities a year or less. If possible, current liabilities are listed in the order that they are to are liabilities due to be paid. be paid within a year.

Current Liabilities .; Accounts Payable Taxes Payable Salaries Owing Payable

Long-Term Liabilities Long-term liabilities are liabilities that are not due to be paid for at least a year. A Long-term liabilities payable in 2 years or a mortgage payable in 25 years are examples of long-term are liabilities that liabilities. are not due to be paid for at least a year. Owner's Section of the Balance Sheet *4 The owner's equity in a business increases when the business operates profitably. Owner's equity decreases when there has been a net loss and when the owner with­ draws assets from the business. 176 (;hapter 5 The Work Sheet and Classi[ted Financial Statements

The owner's equity section of the balance sheet in Figure 5-6 is an example of equity increasing as a result of Gold's Gym's earning a net income which is greater than the owner's withdrawals from the business. Figure 5-7 shows how the equity section of a balance sheet is set up to record a net loss.

Owner's Equity O'Brien, Capital November 1 $99 245 Less: Net Loss for November $1 200 Less: O'Brien, Drawings 1 800 Decrease in Capital 3 000 O'Brien, Capital November 30 $96 245

Figure S-7 Net less

It is possible for a business to earn a net income yet still have a decrease in owner's equity. This 'happens when the withdrawals by the owner are greater than the net income. Figure 5-8 illustrates the set-up of the equity section when withdrawals are greater than net income.

Owner's Equity O'Brien, Capital November 1 $99 245 Add: Net Income for November $1 000 Less: O'Brien, Drawings 1 800 Decrease in Capital 800 O'Brien, Capital November 30 $98 445

Figure 5-8 Withdrawals greater thar1 net income

Supporting Statements and Schedules In addition to the basic and balance sheet, a number of additional statements or schedules may be used to provide fmancial information.

Statement of Owner's Equity The statement of The statement of owner's equity is an example of a supporting statement. This state­ owner's equity de­ ment provides the owner of the business with the data regarding the change in value scribes the changes of the owner's equity for an period. It is prepared separately from the in owner's equity for the accounting balance sheet. The owner's equity balance at the end of the period is shown on the period. balance sheet instead of the full calculation. Figure 5-9 illustrates a statement of owner's equity. The balance sheet for Gold's Gym in Figure 5-6 could have been presented with the separate statement of owner's equity shown in Figure S-9. In such a case, the final balance of the O'Brien, Capital account, $91 630, would be shown on the balance sheet in place of the complete equity calculation. This is illustrated in the balance sheet in Figure 5-10. Unit 10 Classified Financial Statements 177

Gold's Gym Statement of Owner's Equity For the month ended November 30, 19-- O'Brien, Capital November 1 $90 680 Add: Net Income $2 450 Less: O'Brien, Drawings 1 500 Increase in Capital 950 O'Brien, Capital November 30 $91 630

Figure 5-9 Statenunt of owner's equiry

Gold's Gym Balance Sheet November 30, 19-- Assets Current Assets Cash $ 7 800 Accounts Receivable 2 600 Office Supplies 695 Total Current Assets $ 11 095 Fixed Assets Land 25 000 Building 110 000 Training Equipment Total Fixed Assets 234 235 Total Assets $245 330

Liabilities and Owner's Equity Current Liabilities Accounts Payable $ 10 700 Long-Term Liabilities Bank Loan $ 63 000 Mortgage Payable 80 000 Total Long-Term Liabilities 143 000 Total Liabilities 153 700 Owner's Equity O'Brien, Capital November 30 91 630 Total Liabilities and Owner's Equity $245 330

Figu.re 5"-10 Balance sheet A supporting sched­ Schedule of Accounts Receivable ule provides details Supporting schedules are used to provide details about an item on a main statement. An about an item on a example of a supporting schedule is the schedule of accounts receivable, shown in main statement. I 178 Chapter 5 The Work Sheet and Classifred Financial Statements

Figure 5-11. It provides a listing of the individual accounts receivable and the amounts owed. This provides the details regarding the Accounts Receivable total on the balance sheet. In Figure 5-10, the Accounts Receivable total on the balance sheet is $2 600. Further information about the amount owed by each customer is found on the schedule (Figure 5-11). Notice that the total of the schedule, $2 600, is the same as the Accounts Receivable total on the balance sheet (Figure 5- 10).

Gold's Gym Schedule of Accounts Receivable November 30, 19-- B. Adams $ 250 C. Brown 250 L. Foster 200 W. Lane 200 D. Mclssac 300 K. Owen .. · 100 R. Rand 200 G. Smith 250 B. Taylor 250 H . Vanede 300 K. Wier 100 A. Wine 200 Total Accounts Receivable $2 600

Figure S-11 Schedule of accounts receivable

Supporting schedules and statements may be prepared whenever the feels they would provide additional useful infonnation for the readers of the fmancial statements. ,

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND CONCEPTS In this chapter, you learned four Generally Accepted Accounting Principles and concepts: • A work sheet is not a formal accounting statement. It is a device that organizes accounting data required for the preparation of financial statements. • Current assets are listed on the classified balance sheet in order of liquidity. • Assets with the longest life are listed first in the fixed assets section of the balance sheet. • Fixed assets are recorded using the cost principle. Unit 10 Classified Financial Statements 179

What Have I Learned in Unit 10?

• To prepare a classified balance sheet Ifyou have learned the material in Unit 10, you • To defme current and fixed assets and current are ready to proceed to Unit 11. To determine if and long-term liabilities you are ready to proceed, your teacher may now • To prepare supporting statements and schedules wish to give you a review sheet and test for Unit 10.

Check Your Reading Questions 13. What is a classified fmancial statement? 16. What effect does a withdrawal of assets from 14. Explain the following terms: the business by the owner have on owner's (a) equity? (b) Fixed asset 17. (a) What effect does a net loss have on the (c) Liquidity order owner's equity? (d) Current liability (b) What effect does a net income have on (e) Long-term liability the owner's equity? 15. Explain the cost principle as it is applied to fixed assets on the balance sheet.

Apply Your Knowledge

Exercises Part A 4. Classify each of the following as a current asset, fixed asset, current liability, or long-term liability: (a) Accounts Receivable (g) Automobile (b) Land (h) Mortgage Payable (c) Bank Loan (6 months) (i) Taxes Owing (d) Office Supplies (j) Government Bonds (e) Delivery Truck (k) Accounts Payable (f) Prepaid Rent 5. (a) List the current assets in exercise 4 in order of liquidity. (b) List the fixed assets in exercise 4 in proper order. 6. The completed work sheet for the month of January for D. Adams, a lawyer, is on page 180. Prepare the income statement and classified balance sheet. 7. (a) Using the on page 180, prepare a work sheet for the three months ended September 30, 19-- for the Cedar Hill Golf Club. (b) Prepare an income statement, statement of owner's equity, and classified balance sheet.