WEBVTT

NOTE Financial position and the balance sheet

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You are listening to Reading 3-1 of the A C C 300 course reading: Financial

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position and the balance sheet.

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A balance sheet reports what a company controls,

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what it owes, and the residual interest at one date.

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The chapter asks where each reported amount belongs, what that amount

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measures, and which conclusions it can support.

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Millbrook Equipment, a company that sells and services commercial equipment,

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carries the worked example.

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Clearwater Commercial Cleaning appears at the end for you to work on your own.

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The written chapter shows the complete Millbrook balance sheet, the

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calculations, and the links to earlier chapters, and it hides each Clearwater

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answer until you ask for it.

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In the previous chapter, we examined when a company records revenue.

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That discussion concerned activity during a period.

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A balance sheet is a snapshot of a company's reported financial position at a

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particular date.

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It reports the company's assets, liabilities, and shareholders' equity.

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Assets are resources the company controls that are expected to provide future

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economic benefits.

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Liabilities are obligations the company must settle.

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Shareholders' equity is the residual interest in reported assets after

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reported liabilities are deducted.

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The two sides of the statement are not two separate piles of resources.

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Liabilities and equity are claims on the resources reported as assets.

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Companies with similar total assets can have very different financial

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positions.

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An equipment dealer may hold machines for sale, while a cleaning company may

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use similar machines for years to provide services.

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A balance sheet may also omit an economically useful resource or report an

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asset at an amount that is not its current sale price.

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Reading the statement requires attention to what each reported amount

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represents,

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how the company measures it, and what the statement does not establish.

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The classified balance sheet.

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A refresher on current and noncurrent classification.

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Current assets generally include resources expected to be sold,

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collected, or consumed within a year or the normal operating cycle, whichever

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is longer.

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Assets retained for use through repeated cycles are generally noncurrent.

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The written chapter links to the lesson on classifying the current position.

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A classified balance sheet separates current assets from noncurrent assets and

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current liabilities from noncurrent liabilities.

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The statement reports current subtotals separately from noncurrent assets and

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liabilities, while all groups remain part of total assets or total

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liabilities.

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Measurement establishes the amount reported for an item.

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Classification establishes where that amount appears on the balance sheet.

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Moving an amount between current and noncurrent categories does not, by

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itself, change the reported amount or total assets.

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A carrying amount is the amount at which an asset or liability is reported on

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the balance sheet at a particular date after applicable accounting

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adjustments.

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For equipment measured at cost, those adjustments include accumulated

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depreciation.

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For receivables, the carrying amount is reduced by the allowance for credit

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losses.

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If you need to reconnect assets, liabilities, and equity, the written chapter

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links to the balance-sheet section of Chapter 3.

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Asset classification by use and timing.

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Identify the resource before classifying it.

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Before deciding whether an asset is current or noncurrent, identify the kind

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of resource it represents.

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Cash may be available for current operations unless a restriction limits its

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use.

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Receivables are claims against customers that the company expects to collect.

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Inventory consists of goods held for sale or for use in producing goods for

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sale. Prepayments represent benefits the company will consume in future operations.

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Other assets serve different purposes.

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Investments may provide returns or support a continuing relationship.

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Property and equipment provide services through repeated periods of use.

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Intangible assets may represent contractual or legal rights, and some

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economically useful resources may not qualify for separate recognition.

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Classification adds information about expected use,

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sale,

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collection, or consumption.

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It does not change the underlying type of resource.

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Current and noncurrent assets.

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Current assets include cash and resources the company expects to sell,

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collect, or consume within 1 year or the normal operating cycle, whichever is

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longer.

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Resources the company expects to use through repeated periods are noncurrent.

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A machine held for ordinary sale to customers is inventory, while the same

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type of machine held for use in operations is noncurrent equipment.

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Its physical form does not determine the classification.

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Current assets include both resources the company expects to convert to cash

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and resources it expects to consume.

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A receivable is converted to cash when the customer pays.

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Inventory must first be sold and, if the sale is on credit, the resulting

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receivable must then be collected.

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Prepayments are different: they represent future benefits, such as insurance

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coverage or rent, that the company consumes rather than converts to cash.

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These differences matter when considering whether current assets can help meet

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a particular obligation.

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A receivable collectible later in the year may be classified as current even

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though the company needs cash to pay a supplier next week.

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Current classification therefore does not, by itself, mean that a resource is

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immediately available to satisfy an obligation.

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The operating cycle is the period of time from acquiring or producing goods

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for sale, or providing a service, to collecting cash from customers.

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It helps determine the period used to classify certain assets and liabilities

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arising from ordinary operations as current or noncurrent.

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For a company that sells goods, the operating cycle begins when the company

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acquires or produces inventory and ends when it collects cash from customers.

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If the company sells on credit, the sale creates a receivable, and the cycle

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continues until the customer pays.

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For a service company, the corresponding process begins when the company uses

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labor, supplies, and other resources to provide the service and ends when it

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collects cash from the customer.

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If the company bills after providing the service, the receivable remains part

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of the process until collection.

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Issuing shares and borrowing money are financing activities, not steps in the

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operating cycle.

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The company may use that cash to buy inventory or pay employees, but obtaining

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financing does not make the cash part of the sale-and-collection process.

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Assets used to operate the business also generally remain outside the

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operating cycle.

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Millbrook Equipment sells new and reconditioned grounds-maintenance equipment,

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parts, and repair services.

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Its workshop machines help employees prepare inventory, and its delivery

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vehicles transport goods to customers.

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Those assets support the sale-and-collection process, but they do not pass

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through it as inventory or receivables.

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Millbrook uses them in operations rather than holding them for sale, so it

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reports them as noncurrent property and equipment.

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Their classification does not depend on the length of the operating cycle.

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For current classification, use 12 months or the company's normal operating

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cycle, whichever is longer.

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A company with several operating cycles within 12 months, or with no clearly

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defined operating cycle, uses a 12-month period.

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The Financial Accounting Standards Board states this time rule in its

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Accounting Standards Codification, at A S C Topic 210, Subtopic 10, Section

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45, paragraph 3.

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A company with an 18-month operating cycle may classify inventory expected to

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be sold in 15 months as current.

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The same principle keeps inventory and the receivables arising from its sale

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within the current classification while the company completes its normal

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operating process.

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An unusually slow-moving item, however, does not by itself establish a longer

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operating cycle.

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Millbrook completes its ordinary purchase-to-collection process in 4 months.

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Because its operating cycle is shorter than 12 months, Millbrook uses a

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12-month period to classify inventory held for sale and trade receivables.

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Its workshop machines and delivery vehicles do not enter that determination

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because they support the sale-and-collection process but do not pass through

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it as inventory or receivables.

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Check your understanding.

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In a business with an 18-month operating cycle, would delivery vehicles used

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for 6 years become current because employees use them during the cycle?

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Pause to consider your answer.

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Here is the explanation.

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No.

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The vehicles help the company deliver goods, but they do not pass through the

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operating cycle as inventory or receivables.

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They are noncurrent property and equipment.

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The length of the operating cycle does not govern their classification.

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Prepayments,

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restricted cash, and intangible assets.

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A prepayment is an amount paid for a benefit the company has not yet received

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or consumed.

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The benefit may be insurance coverage or another service.

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The company consumes the prepaid asset as it receives the related service.

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Classify the portion the company expects to consume during the current

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classification period as current.

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F A S B explains this treatment in A S C Topic 210, Subtopic 10, Section 45,

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paragraph 2.

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Intended use can change the classification of the same physical property.

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Land held for a factory is noncurrent because the company uses it in

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operations.

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Land held for sale by a property developer is inventory because the company

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expects to sell it in ordinary operations.

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Restrictions can also make a resource unavailable for current operations.

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Ask whether the restriction leaves the company free to use the cash for

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current obligations.

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Cash reserved for constructing a long-lived asset cannot serve that purpose,

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even if the company will spend it soon.

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A S C Topic 210, Subtopic 10, Section 45, paragraph 4 excludes such cash from

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current assets.

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A restriction that still permits current use does not automatically make cash

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noncurrent.

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Assets without physical substance are called intangible assets.

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A purchased right used through several years of operations normally belongs

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among noncurrent assets.

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Physical form does not determine classification.

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The company's use of the right matters, while its detailed measurement rules

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are a separate question.

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Apply the timing, use, and restriction principles to Millbrook's prepaid

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insurance and construction cash.

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The insurance provides coverage during 2027, so Millbrook will consume the

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prepaid benefit during its current classification period.

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The construction cash must be used for a workshop in 2028 and is unavailable

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for current operations.

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Millbrook reports the insurance as current and the construction cash as

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noncurrent.

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Millbrook classifies its balances from these facts:

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Resource,

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Operating cash;

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Relevant fact,

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Millbrook can spend it on current operations;

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Classification, Current.

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Resource,

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Trade receivables;

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Relevant fact,

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Customers are expected to pay during the normal collection period;

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Classification,

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Current.

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Resource,

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Inventory;

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Relevant fact, Millbrook will sell the machines and parts in its normal

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operating cycle;

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Classification, Current.

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Resource,

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Prepaid insurance;

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Relevant fact, The coverage applies to the following year;

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Classification,

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Current.

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Resource,

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Construction cash;

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Relevant fact, Millbrook must use it to construct a workshop in 2028;

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Classification, Noncurrent.

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Resource, Long-term investment;

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Relevant fact, Millbrook holds it for a continuing business relationship;

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Classification, Noncurrent.

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Resource,

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Land and equipment;

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Relevant fact, Millbrook uses them through repeated operating cycles;

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Classification, Noncurrent.

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Check your understanding.

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Consider two separate balances.

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One company holds land for its factory.

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A property developer holds land for sale in its normal business.

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Must both classify the land as noncurrent?

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Pause to consider your answer.

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Here is the explanation.

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No.

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The factory land is held for continuing use and is noncurrent.

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The developer's land is inventory held for sale in its normal operating cycle.

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The intended use differs even though both accounts concern land.

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If the facts do not state how an asset will be used,

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identify that missing information before assigning a classification.

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An account name may describe the resource without establishing its intended

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use.

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The written chapter links to the section of Chapter 2 on prepaid expenses.

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That section shows the adjustment that moves the used portion of a prepayment

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to expense.

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Liabilities and equity.

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Identify the obligation before classifying it.

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Before deciding whether a liability is current or noncurrent, identify what

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the company owes, what performance would settle it, and when settlement is

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expected.

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Trade payables and accrued expenses generally require cash payment.

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A customer advance represents an obligation to provide promised goods or

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services.

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Borrowings require repayment under their contractual terms.

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Other obligations may require cash,

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goods, services, or another specified performance.

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Classification distinguishes obligations expected to be settled within the

257
00:17:24.999 --> 00:17:29.279
current classification period from those expected to remain outstanding

258
00:17:29.279 --> 00:17:29.839
longer.

259
00:17:30.479 --> 00:17:34.959
It does not change the nature of the obligation or the performance the company

260
00:17:34.959 --> 00:17:35.319
owes.

261
00:17:37.404 --> 00:17:40.064
Settlement of current obligations.

262
00:17:41.264 --> 00:17:46.564
Current liabilities generally include obligations arising in the operating

263
00:17:46.564 --> 00:17:53.064
cycle and other obligations expected to be settled within 12 months or the

264
00:17:53.064 --> 00:17:55.224
normal operating cycle, whichever is longer.

265
00:17:56.304 --> 00:18:01.904
For operating liabilities, use the same normal operating cycle considered for

266
00:18:01.904 --> 00:18:02.784
current assets.

267
00:18:02.784 --> 00:18:06.364
A S C Topic 210,

268
00:18:07.204 --> 00:18:10.224
Subtopic 10, Section 45,

269
00:18:11.424 --> 00:18:17.264
paragraphs 8 and 9 describe ordinary operating obligations and other

270
00:18:17.264 --> 00:18:18.384
short-term obligations.

271
00:18:19.864 --> 00:18:23.824
Certain borrowing arrangements are subject to additional classification rules,

272
00:18:24.184 --> 00:18:25.524
which the next reading addresses.

273
00:18:26.484 --> 00:18:32.124
To classify an obligation, identify what the company owes and when it expects

274
00:18:32.124 --> 00:18:32.904
to settle it.

275
00:18:33.844 --> 00:18:37.724
The form of settlement does not by itself determine classification.

276
00:18:38.904 --> 00:18:43.724
An account payable may be settled with cash, while a customer advance is

277
00:18:43.724 --> 00:18:47.184
ordinarily settled by providing promised goods or services.

278
00:18:48.264 --> 00:18:52.044
Either may be current when settlement is expected within that period.

279
00:18:53.044 --> 00:18:57.884
Accounts payable and wages payable normally require cash settlement.

280
00:18:58.864 --> 00:19:02.884
Their classification depends on the obligation outstanding at the reporting

281
00:19:02.884 --> 00:19:05.064
date and when payment is required.

282
00:19:05.844 --> 00:19:11.464
For example, an accrued wage expense creates a liability that remains until

283
00:19:11.464 --> 00:19:14.314
the company pays the amount owed to employees.

284
00:19:15.164 --> 00:19:19.904
A customer advance arises when the company receives payment before it provides

285
00:19:19.904 --> 00:19:21.264
the promised goods or services.

286
00:19:21.824 --> 00:19:26.064
The company has a liability because it still owes that performance to the

287
00:19:26.064 --> 00:19:26.344
customer.

288
00:19:27.064 --> 00:19:32.264
A company may label the balance a customer deposit, customer advance, or

289
00:19:32.264 --> 00:19:32.844
similar term.

290
00:19:33.584 --> 00:19:39.124
When the payment relates to a contract that qualifies under ASC 606, the

291
00:19:39.124 --> 00:19:40.944
balance is a contract liability.

292
00:19:42.104 --> 00:19:46.844
Chapter 8 explained that collecting cash does not by itself create revenue.

293
00:19:47.953 --> 00:19:52.653
The company settles the liability when it provides the promised goods or

294
00:19:52.653 --> 00:19:58.333
services, which may require additional materials, labor, or other resources.

295
00:19:59.933 --> 00:20:04.333
Classify a customer advance based on when the company expects to perform.

296
00:20:05.833 --> 00:20:10.273
Advances for goods or services to be supplied within that period are generally

297
00:20:10.273 --> 00:20:10.693
current.

298
00:20:12.153 --> 00:20:16.493
Obligations involving delivery or performance deferred beyond that period

299
00:20:16.493 --> 00:20:18.433
require separate consideration.

300
00:20:18.433 --> 00:20:24.993
A S C Topic 210, Subtopic 10, Section 45,

301
00:20:25.993 --> 00:20:30.493
paragraph 8, item b distinguishes these longer-term obligations.

302
00:20:32.213 --> 00:20:37.193
Millbrook's accounts payable arose from purchases of goods and services, and

303
00:20:37.193 --> 00:20:41.413
its wages payable arose from work already performed by employees.

304
00:20:42.133 --> 00:20:46.813
Both are due during 2027 and require cash settlement.

305
00:20:47.893 --> 00:20:53.193
Millbrook expects to deliver in February 2027 the equipment associated with

306
00:20:53.193 --> 00:20:58.073
30,000 dollars of customer advances, so it reports the advances as current

307
00:20:58.073 --> 00:20:58.613
liabilities.

308
00:20:59.848 --> 00:21:04.888
The written chapter links to the section of Chapter 8 on contract liabilities.

309
00:21:05.908 --> 00:21:07.688
That section connects performance,

310
00:21:08.548 --> 00:21:09.818
billing, and collection.

311
00:21:11.677 --> 00:21:15.007
Current and noncurrent portions of a loan.

312
00:21:15.837 --> 00:21:19.957
A borrowing can have both current and noncurrent portions.

313
00:21:20.857 --> 00:21:24.117
For an ordinary loan with scheduled principal payments,

314
00:21:25.177 --> 00:21:29.357
classify the principal due within the coming 12 months as current.

315
00:21:30.517 --> 00:21:35.157
Classify the remaining principal as noncurrent unless another circumstance

316
00:21:35.157 --> 00:21:36.977
requires current classification.

317
00:21:36.977 --> 00:21:43.177
A S C Topic 210, Subtopic 10, Section 45,

318
00:21:44.077 --> 00:21:49.917
paragraph 9, item b includes scheduled maturities of long-term obligations

319
00:21:49.917 --> 00:21:51.477
among current liabilities.

320
00:21:52.897 --> 00:21:57.357
Classification is based on the repayment requirements that remain at the

321
00:21:57.357 --> 00:22:00.257
reporting date, not on the loan's original term.

322
00:22:00.857 --> 00:22:06.177
A loan may originally have been payable over many years, but the portion now

323
00:22:06.177 --> 00:22:08.837
due within the coming 12 months is current.

324
00:22:10.177 --> 00:22:14.997
Separating the current and noncurrent portions shows the near-term repayment

325
00:22:14.997 --> 00:22:19.217
requirement without treating amounts due in later periods as currently

326
00:22:19.217 --> 00:22:19.597
payable.

327
00:22:20.397 --> 00:22:23.677
The split changes presentation, not total debt.

328
00:22:25.157 --> 00:22:28.717
Millbrook owes 280,000 dollars of loan principal.

329
00:22:29.077 --> 00:22:35.677
It must pay 40,000 dollars each December 31 from 2027 through 2033.

330
00:22:37.117 --> 00:22:40.337
Interest has been paid through December 31, 2026.

331
00:22:41.217 --> 00:22:46.617
No covenant violation, refinancing arrangement, or other condition changes the

332
00:22:46.617 --> 00:22:47.957
scheduled classification in this case.

333
00:22:48.877 --> 00:22:54.837
This example has no unpaid interest at December 31, 2026, so it classifies

334
00:22:54.837 --> 00:22:56.277
only loan principal.

335
00:22:56.957 --> 00:23:01.037
Depending on a note's payment terms, a company may also report accrued

336
00:23:01.037 --> 00:23:02.057
interest payable.

337
00:23:02.857 --> 00:23:05.417
Chapter 10 addresses accrued obligations.

338
00:23:06.297 --> 00:23:09.957
Chapter 13 develops how a company calculates interest on notes.

339
00:23:11.177 --> 00:23:12.457
Principal repayment,

340
00:23:13.417 --> 00:23:15.337
Due during 2027;

341
00:23:16.617 --> 00:23:22.817
Classification at December 31, 2026, 40,000 dollars current.

342
00:23:24.817 --> 00:23:25.457
Principal repayment,

343
00:23:26.317 --> 00:23:28.117
Due after 2027;

344
00:23:29.457 --> 00:23:37.437
Classification at December 31, 2026, 240,000 dollars noncurrent.

345
00:23:37.437 --> 00:23:39.077
Principal repayment,

346
00:23:39.877 --> 00:23:41.717
Total principal owed;

347
00:23:42.637 --> 00:23:48.979
Classification at December 31, 2026, 280,000 dollars.

348
00:23:49.679 --> 00:23:55.039
Millbrook reports the payment requirement of 40,000 dollars among current

349
00:23:55.039 --> 00:24:00.879
liabilities and the remaining 240,000 dollars among noncurrent liabilities.

350
00:24:01.999 --> 00:24:07.839
Together, the two classifications account for the full 280,000 dollars owed

351
00:24:07.839 --> 00:24:12.459
while distinguishing the amount due within the coming 12 months from the

352
00:24:12.459 --> 00:24:13.159
amount due later.

353
00:24:14.069 --> 00:24:15.339
Check your understanding.

354
00:24:16.919 --> 00:24:20.319
Millbrook originally borrowed the money under a long-term agreement.

355
00:24:21.079 --> 00:24:26.199
Does that original term keep every remaining payment noncurrent?

356
00:24:26.199 --> 00:24:27.649
Pause to consider your answer.

357
00:24:28.859 --> 00:24:30.069
Here is the explanation.

358
00:24:30.959 --> 00:24:31.259
No.

359
00:24:31.519 --> 00:24:35.139
The remaining payment dates govern this ordinary example.

360
00:24:35.619 --> 00:24:42.019
The 40,000 dollars due during 2027 is current even though the original loan

361
00:24:42.019 --> 00:24:43.179
had a longer term.

362
00:24:45.073 --> 00:24:47.933
Equity as a residual interest.

363
00:24:49.053 --> 00:24:54.933
The written chapter links to the statement of changes in equity in Chapter 3.

364
00:24:55.493 --> 00:24:57.533
That section separates income,

365
00:24:58.373 --> 00:25:00.593
owner contributions, and distributions.

366
00:25:01.939 --> 00:25:08.119
Equity is the residual interest in a company's assets: the amount remaining

367
00:25:08.119 --> 00:25:11.179
after its liabilities are deducted.

368
00:25:12.099 --> 00:25:13.099
In equation form,

369
00:25:14.079 --> 00:25:18.779
equity equals reported assets minus reported liabilities.

370
00:25:20.499 --> 00:25:23.919
Equity is determined from all reported assets and liabilities.

371
00:25:24.499 --> 00:25:28.579
It is not a separate resource that the company sets aside for shareholders.

372
00:25:29.579 --> 00:25:35.179
Assets show where the company's reported resources are held or used.

373
00:25:35.859 --> 00:25:39.299
Liabilities and equity show the claims on those resources.

374
00:25:40.579 --> 00:25:43.079
Retained earnings is not a cash account.

375
00:25:43.859 --> 00:25:46.649
It records cumulative income and losses,

376
00:25:47.579 --> 00:25:50.379
distributions to owners, and other required adjustments.

377
00:25:51.199 --> 00:25:56.239
A transaction changes equity when it changes the difference between reported

378
00:25:56.239 --> 00:25:58.399
assets and reported liabilities.

379
00:25:59.619 --> 00:26:05.059
When Millbrook earns repair revenue in cash, assets increase while liabilities

380
00:26:05.059 --> 00:26:09.029
do not, so equity increases by the amount of revenue.

381
00:26:09.999 --> 00:26:13.459
When Millbrook records wage expense that has not yet been paid,

382
00:26:14.359 --> 00:26:19.099
liabilities increase without a corresponding increase in assets, so equity

383
00:26:19.099 --> 00:26:21.279
decreases by the amount of the expense.

384
00:26:22.659 --> 00:26:25.899
Owner contributions and distributions can also change equity.

385
00:26:26.759 --> 00:26:31.419
Other transactions change assets or liabilities without changing equity.

386
00:26:32.679 --> 00:26:36.759
Exchanging one asset for another at equal carrying amounts changes the

387
00:26:36.759 --> 00:26:40.369
composition of assets but not total assets or equity.

388
00:26:41.419 --> 00:26:45.699
Settling a liability for its carrying amount reduces assets and liabilities by

389
00:26:45.699 --> 00:26:48.379
the same amount, leaving equity unchanged.

390
00:26:49.339 --> 00:26:54.539
Within shareholders' equity, common stock reflects amounts recorded for issued

391
00:26:54.539 --> 00:26:54.899
shares.

392
00:26:55.679 --> 00:27:00.499
Common stock and retained earnings help explain how equity arose, but they do

393
00:27:00.499 --> 00:27:03.979
not identify where the company's resources are currently held.

394
00:27:04.819 --> 00:27:08.659
A company can report retained earnings while using its resources to purchase

395
00:27:08.659 --> 00:27:10.059
inventory or equipment,

396
00:27:10.899 --> 00:27:13.079
repay obligations, or for other purposes.

397
00:27:14.214 --> 00:27:22.434
Millbrook reports 1,200,000 dollars of assets and 640,000 dollars of

398
00:27:22.434 --> 00:27:28.474
liabilities, resulting in 560,000 dollars of reported equity, which is

399
00:27:28.474 --> 00:27:33.674
1,200,000 dollars minus 640,000 dollars.

400
00:27:33.674 --> 00:27:41.934
That equity consists of 200,000 dollars of common stock and 360,000 dollars of

401
00:27:41.934 --> 00:27:42.674
retained earnings.

402
00:27:43.714 --> 00:27:49.374
The retained earnings balance of 360,000 dollars is not a cash balance;

403
00:27:50.194 --> 00:27:54.034
Millbrook's cash must be identified separately among its asset accounts.

404
00:27:55.294 --> 00:27:56.174
Check your understanding.

405
00:27:57.254 --> 00:28:01.234
Millbrook buys equipment for cash at its recorded purchase cost.

406
00:28:01.704 --> 00:28:05.434
With no other effect, does equity fall by the payment?

407
00:28:06.614 --> 00:28:07.964
Pause to consider your answer.

408
00:28:08.794 --> 00:28:09.904
Here is the explanation.

409
00:28:10.954 --> 00:28:11.114
No.

410
00:28:12.254 --> 00:28:15.714
Cash decreases and equipment increases by the same amount.

411
00:28:16.734 --> 00:28:21.194
Total assets and liabilities are unchanged, so equity is unchanged.

412
00:28:22.034 --> 00:28:25.474
Later expenses from using the equipment are a separate event.

413
00:28:27.308 --> 00:28:28.968
Classified balance sheets.

414
00:28:30.088 --> 00:28:35.208
A classified balance sheet groups individual carrying amounts into current and

415
00:28:35.208 --> 00:28:40.528
noncurrent categories and reports subtotals for current assets and current

416
00:28:40.528 --> 00:28:40.888
liabilities.

417
00:28:42.268 --> 00:28:46.448
Classification changes how amounts are presented, but not whether they are

418
00:28:46.448 --> 00:28:49.328
included in total assets or total liabilities.

419
00:28:50.348 --> 00:28:55.328
Total liabilities plus shareholders' equity must still equal total assets.

420
00:28:56.248 --> 00:29:01.108
The statement is prepared from adjusted account balances after applying the

421
00:29:01.108 --> 00:29:02.688
relevant classification rules.

422
00:29:03.808 --> 00:29:08.308
When a balance sheet label includes net, a related deduction has already been

423
00:29:08.308 --> 00:29:09.048
subtracted.

424
00:29:09.868 --> 00:29:14.848
Equipment may be reported net of accumulated depreciation, and receivables may

425
00:29:14.848 --> 00:29:18.028
be reported net of an allowance for expected credit losses.

426
00:29:18.628 --> 00:29:23.328
The resulting net carrying amount is the amount classified and presented on

427
00:29:23.328 --> 00:29:23.968
the balance sheet.

428
00:29:25.308 --> 00:29:28.588
Millbrook's accountant prepares the following statement from its adjusted

429
00:29:28.588 --> 00:29:32.048
balances and the classification conclusions established above.

430
00:29:33.100 --> 00:29:34.440
Millbrook Equipment,

431
00:29:35.340 --> 00:29:41.700
balance sheet at December 31, 2026, in United States dollars.

432
00:29:43.480 --> 00:29:44.040
Current assets:

433
00:29:45.560 --> 00:29:50.300
cash available for operations, 90,000 dollars.

434
00:29:50.300 --> 00:29:55.520
Trade receivables, net, 120,000 dollars.

435
00:29:55.520 --> 00:29:59.320
Inventory, 250,000 dollars.

436
00:29:59.320 --> 00:30:02.640
Prepaid insurance, 20,000 dollars.

437
00:30:02.640 --> 00:30:07.660
Total current assets, 480,000 dollars.

438
00:30:07.660 --> 00:30:09.780
Noncurrent assets:

439
00:30:11.020 --> 00:30:15.313
cash restricted for workshop construction, 60,000 dollars.

440
00:30:15.313 --> 00:30:20.140
Long-term investment, 40,000 dollars.

441
00:30:20.140 --> 00:30:24.660
Land used in operations, 100,000 dollars.

442
00:30:24.660 --> 00:30:29.240
Property and equipment, net, 520,000 dollars.

443
00:30:29.240 --> 00:30:34.720
Total noncurrent assets, 720,000 dollars.

444
00:30:34.720 --> 00:30:39.680
Total assets, 1,200,000 dollars.

445
00:30:39.680 --> 00:30:40.600
Current liabilities:

446
00:30:41.620 --> 00:30:46.120
accounts payable, 216,000 dollars.

447
00:30:46.120 --> 00:30:49.220
Wages payable, 18,000 dollars.

448
00:30:49.220 --> 00:30:52.300
Customer advances, 30,000 dollars.

449
00:30:52.300 --> 00:30:57.040
Other current operating liabilities, 96,000 dollars.

450
00:30:57.040 --> 00:31:00.920
Current portion of loan, 40,000 dollars.

451
00:31:00.920 --> 00:31:04.886
Total current liabilities, 400,000 dollars.

452
00:31:04.886 --> 00:31:06.900
Noncurrent liabilities:

453
00:31:07.740 --> 00:31:13.200
loan payable after 2027, 240,000 dollars.

454
00:31:13.200 --> 00:31:18.000
Total liabilities, 640,000 dollars.

455
00:31:18.000 --> 00:31:22.940
Shareholders' equity: common stock, 200,000 dollars.

456
00:31:22.940 --> 00:31:27.060
Retained earnings, 360,000 dollars.

457
00:31:27.060 --> 00:31:31.780
Total shareholders' equity, 560,000 dollars.

458
00:31:31.780 --> 00:31:37.297
Total liabilities and shareholders' equity, 1,200,000 dollars.

459
00:31:37.997 --> 00:31:43.837
Millbrook reports 1,200,000 dollars of total assets,

460
00:31:44.877 --> 00:31:49.677
but only 90,000 dollars is cash available for current operations.

461
00:31:50.257 --> 00:31:56.297
The remaining assets include amounts to collect, goods to sell, prepaid

462
00:31:56.297 --> 00:32:00.477
benefits to consume, and resources held for longer-term use.

463
00:32:01.737 --> 00:32:07.077
Treating all of those assets as immediately available cash would obscure the

464
00:32:07.077 --> 00:32:11.757
time and additional steps required before some of them can support payment of

465
00:32:11.757 --> 00:32:12.137
obligations.

466
00:32:14.212 --> 00:32:17.612
Use the notes to understand reported balances.

467
00:32:18.772 --> 00:32:21.972
The balance sheet itself summarizes reported amounts.

468
00:32:22.932 --> 00:32:26.052
The notes explain many of the amounts' contents,

469
00:32:27.012 --> 00:32:28.892
terms, restrictions, and measurement.

470
00:32:29.632 --> 00:32:35.812
A caption such as "other assets" or "other liabilities" may combine several

471
00:32:35.812 --> 00:32:36.612
different items.

472
00:32:37.912 --> 00:32:42.052
Notes may also explain restricted cash, the composition of property and

473
00:32:42.052 --> 00:32:47.412
equipment, debt maturities, how the company estimated an allowance, or the

474
00:32:47.412 --> 00:32:49.132
terms of significant obligations.

475
00:32:51.072 --> 00:32:53.652
Use the balance sheet to identify the question.

476
00:32:54.592 --> 00:32:59.652
Then use the relevant note to determine what the reported balance includes and

477
00:32:59.652 --> 00:33:01.912
what facts qualify its interpretation.

478
00:33:03.979 --> 00:33:05.979
Apply this to a public filing.

479
00:33:07.319 --> 00:33:12.239
Open the annual filing you used in Chapter 5, or another company's annual

480
00:33:12.239 --> 00:33:12.579
filing.

481
00:33:13.839 --> 00:33:16.979
Locate its balance sheet and one related note.

482
00:33:18.499 --> 00:33:23.519
Identify what the reported balance includes and one fact from the note that

483
00:33:23.519 --> 00:33:24.599
affects its interpretation.

484
00:33:25.999 --> 00:33:28.279
Limits of reported financial position.

485
00:33:29.759 --> 00:33:30.399
Asset recognition.

486
00:33:31.379 --> 00:33:32.359
In accounting,

487
00:33:33.499 --> 00:33:37.039
recognition means including an item and its amount in the financial

488
00:33:37.039 --> 00:33:37.459
statements.

489
00:33:38.659 --> 00:33:43.279
An economically useful resource does not automatically qualify for recognition

490
00:33:43.279 --> 00:33:44.639
as a separate asset.

491
00:33:45.779 --> 00:33:49.719
Recognition depends on the accounting requirements that apply to the resource

492
00:33:49.719 --> 00:33:53.979
and the circumstances in which the company obtained or developed it.

493
00:33:54.939 --> 00:33:58.779
Economic usefulness and accounting recognition are different judgments.

494
00:33:59.599 --> 00:34:04.519
A resource may contribute to future sales without qualifying as a separately

495
00:34:04.519 --> 00:34:07.299
recognized asset under the applicable accounting guidance.

496
00:34:08.679 --> 00:34:12.959
Costs incurred to develop that resource may instead be recognized as expense

497
00:34:12.959 --> 00:34:13.679
when incurred.

498
00:34:14.779 --> 00:34:19.239
When applicable guidance requires expense recognition, later evidence that the

499
00:34:19.239 --> 00:34:23.539
resource helped the business does not by itself create a separately recognized

500
00:34:23.539 --> 00:34:23.979
asset.

501
00:34:25.259 --> 00:34:29.579
Recognition requirements can differ depending on how a company obtains a

502
00:34:29.579 --> 00:34:29.729
resource.

503
00:34:30.699 --> 00:34:34.299
Purchasing an identifiable right may result in a separately recognized

504
00:34:34.299 --> 00:34:35.479
intangible asset.

505
00:34:36.499 --> 00:34:41.059
By contrast, spending that helps build customer loyalty may create economic

506
00:34:41.059 --> 00:34:45.319
value without producing a separately recognized customer-relationship asset.

507
00:34:45.319 --> 00:34:53.619
A S C Topic 350, Subtopic 30, Section 25, paragraph 3 requires certain costs

508
00:34:53.619 --> 00:34:58.419
of internally developing intangible resources to be recognized as expense when

509
00:34:58.419 --> 00:35:01.269
incurred rather than capitalized as assets.

510
00:35:02.179 --> 00:35:05.619
This treatment applies to resources that are not specifically identifiable,

511
00:35:06.299 --> 00:35:09.999
have indeterminate lives, or are inherent in the continuing business.

512
00:35:11.073 --> 00:35:16.613
Other accounting guidance may permit or require capitalization in different

513
00:35:16.613 --> 00:35:17.293
circumstances.

514
00:35:18.613 --> 00:35:24.213
Chapter 23 develops those recognition and capitalization rules for intangible

515
00:35:24.213 --> 00:35:24.673
assets.

516
00:35:26.393 --> 00:35:31.373
Millbrook has developed repeat business through years of reliable service.

517
00:35:32.553 --> 00:35:37.793
Those customer relationships may contribute to future sales, but they were

518
00:35:37.793 --> 00:35:41.193
developed internally rather than acquired as a separate asset.

519
00:35:42.493 --> 00:35:47.533
As a result, Millbrook does not report a separate customer-relationship asset

520
00:35:47.533 --> 00:35:48.913
for them in this example.

521
00:35:49.673 --> 00:35:54.193
Their absence from the balance sheet does not mean they lack economic value;

522
00:35:54.753 --> 00:35:59.313
it reflects the recognition requirements that apply to internally developed

523
00:35:59.313 --> 00:36:00.853
intangible resources.

524
00:36:02.790 --> 00:36:05.090
Measurement of carrying amounts.

525
00:36:06.230 --> 00:36:11.110
A carrying amount is the amount at which an asset is reported on the balance

526
00:36:11.110 --> 00:36:15.470
sheet after applying the relevant measurement requirements and adjustments.

527
00:36:17.450 --> 00:36:20.790
Reported assets do not all use the same measurement basis.

528
00:36:21.970 --> 00:36:27.170
Some carrying amounts reflect cost less amounts already recognized as expense,

529
00:36:27.950 --> 00:36:32.380
while others incorporate estimates about what the company expects to collect.

530
00:36:33.970 --> 00:36:38.790
Adding those carrying amounts produces total reported assets; it does not

531
00:36:38.790 --> 00:36:41.730
produce a total of the assets' current selling prices.

532
00:36:42.850 --> 00:36:48.610
For equipment reported at depreciated cost, the company allocates the asset's

533
00:36:48.610 --> 00:36:53.050
cost to depreciation expense over the periods that benefit from its use.

534
00:36:54.490 --> 00:36:59.090
Accumulated depreciation is the cumulative amount of cost allocated to

535
00:36:59.090 --> 00:37:00.770
depreciation expense to date.

536
00:37:01.950 --> 00:37:06.490
The remaining amount is reported as the asset's carrying amount, subject to

537
00:37:06.490 --> 00:37:08.090
any other required adjustments.

538
00:37:09.710 --> 00:37:14.150
Depreciated cost does not represent an estimate of what a buyer would pay for

539
00:37:14.150 --> 00:37:15.430
the equipment today.

540
00:37:16.470 --> 00:37:21.410
For receivables, an allowance for expected credit losses reduces the amount

541
00:37:21.410 --> 00:37:22.930
reported for customer balances.

542
00:37:23.970 --> 00:37:27.910
The allowance reflects the company's estimate of expected credit losses.

543
00:37:27.910 --> 00:37:37.450
A S C Topic 210, Subtopic 10, Section 45, paragraph 13 requires valuation

544
00:37:37.450 --> 00:37:41.680
allowances to be deducted from the related assets or groups of assets.

545
00:37:42.790 --> 00:37:46.790
The net carrying amount of receivables therefore reflects both the gross

546
00:37:46.790 --> 00:37:49.450
customer balances and the related allowance.

547
00:37:51.330 --> 00:37:54.130
Changes in carrying amounts can arise for different reasons.

548
00:37:54.950 --> 00:37:59.070
A cash collection reduces receivables and increases cash.

549
00:38:00.170 --> 00:38:04.710
An increase in the allowance for expected credit losses also reduces net

550
00:38:04.710 --> 00:38:09.070
receivables, but for a different reason: the company now expects to collect

551
00:38:09.070 --> 00:38:11.230
less of the outstanding customer balances.

552
00:38:12.371 --> 00:38:16.731
That change is generally recognized as credit loss expense.

553
00:38:17.691 --> 00:38:21.991
It brings in no cash and does not mean that customers have paid their

554
00:38:21.991 --> 00:38:22.331
balances.

555
00:38:23.911 --> 00:38:25.971
When a reported asset decreases,

556
00:38:26.991 --> 00:38:31.011
determine whether the change resulted from a transaction, a revised estimate,

557
00:38:31.311 --> 00:38:33.051
or another accounting adjustment.

558
00:38:34.791 --> 00:38:40.531
Millbrook reports 700,000 dollars of depreciable property and equipment less

559
00:38:40.531 --> 00:38:44.311
180,000 dollars of accumulated depreciation,

560
00:38:45.471 --> 00:38:50.391
resulting in a carrying amount of 520,000 dollars.

561
00:38:50.391 --> 00:38:54.751
It reports 126,000 dollars of trade receivables

562
00:38:55.691 --> 00:38:59.491
less an allowance of 6,000 dollars for expected credit losses,

563
00:39:00.491 --> 00:39:04.997
resulting in a net carrying amount of 120,000 dollars.

564
00:39:05.697 --> 00:39:11.077
The written chapter links to the section of Chapter 2 on estimates and

565
00:39:11.077 --> 00:39:11.837
depreciation.

566
00:39:12.757 --> 00:39:17.377
That section separates a supported estimate from an arbitrary amount.

567
00:39:19.246 --> 00:39:21.886
Reported equity and business value.

568
00:39:23.646 --> 00:39:28.346
Reported equity and a business's transaction price measure different things.

569
00:39:29.886 --> 00:39:34.466
Reported equity is based on recognized assets and liabilities at their

570
00:39:34.466 --> 00:39:35.806
reported carrying amounts.

571
00:39:36.846 --> 00:39:41.966
A transaction price also reflects expectations about future performance and

572
00:39:41.966 --> 00:39:42.286
risk,

573
00:39:43.106 --> 00:39:46.866
including the effects of resources that may not be separately recognized on

574
00:39:46.866 --> 00:39:47.546
the balance sheet.

575
00:39:48.466 --> 00:39:53.166
Even when an individual asset is measured using a current-value basis,

576
00:39:54.006 --> 00:39:57.786
total reported equity is not an estimate of the price of the business.

577
00:39:58.826 --> 00:40:02.886
The balance sheet alone therefore cannot establish whether a buyer would pay

578
00:40:02.886 --> 00:40:04.966
more or less than reported equity.

579
00:40:06.066 --> 00:40:12.186
A potential buyer says, "Millbrook reports 560,000 dollars of equity, so

580
00:40:12.186 --> 00:40:15.966
560,000 dollars is the price of the shareholders' interest."

581
00:40:16.966 --> 00:40:20.046
The calculation of reported equity is correct.

582
00:40:21.066 --> 00:40:25.026
The price conclusion requires information that the balance sheet does not

583
00:40:25.026 --> 00:40:25.486
provide.

584
00:40:25.486 --> 00:40:30.966
Millbrook's customer relationships are not separately recognized, and the

585
00:40:30.966 --> 00:40:35.446
carrying amount of its equipment reflects depreciated cost rather than current

586
00:40:35.446 --> 00:40:36.166
market value.

587
00:40:37.206 --> 00:40:41.286
A buyer would also consider expected future performance and the risks

588
00:40:41.286 --> 00:40:42.746
associated with achieving it.

589
00:40:43.706 --> 00:40:49.106
We can conclude that Millbrook reports 560,000 dollars of equity under the

590
00:40:49.106 --> 00:40:50.446
applicable accounting measurements.

591
00:40:51.606 --> 00:40:55.546
We cannot infer the business's transaction price, or whether that price would

592
00:40:55.546 --> 00:40:59.886
be above or below 560,000 dollars, from the balance sheet alone.

593
00:41:01.266 --> 00:41:02.126
Check your understanding.

594
00:41:03.146 --> 00:41:09.446
Another reader says, "Millbrook has 1,200,000 dollars of assets, so it could

595
00:41:09.446 --> 00:41:15.246
raise 1,200,000 dollars immediately by selling them." What is missing from

596
00:41:15.246 --> 00:41:15.706
that claim?

597
00:41:17.066 --> 00:41:18.266
Pause to consider your answer.

598
00:41:18.266 --> 00:41:20.716
Here is the explanation.

599
00:41:22.066 --> 00:41:24.366
Carrying amounts are not immediate sale proceeds.

600
00:41:25.530 --> 00:41:28.330
We need information about sale prices,

601
00:41:29.310 --> 00:41:31.210
the time needed to sell,

602
00:41:32.490 --> 00:41:34.630
restrictions, and selling costs.

603
00:41:36.150 --> 00:41:41.550
Some resources provide services rather than cash proceeds, as prepaid

604
00:41:41.550 --> 00:41:42.450
insurance does.

605
00:41:44.288 --> 00:41:47.228
Working capital and the current ratio.

606
00:41:49.368 --> 00:41:54.248
Liquidity concerns a company's ability to meet near-term obligations as they

607
00:41:54.248 --> 00:41:59.108
come due using resources expected to become available in the near term.

608
00:42:00.848 --> 00:42:02.428
Solvency, by contrast,

609
00:42:03.248 --> 00:42:07.208
concerns the company's ability to meet obligations over longer horizons.

610
00:42:08.708 --> 00:42:14.668
Current classification groups assets expected to be sold, collected, or

611
00:42:14.668 --> 00:42:19.668
consumed and obligations expected to be settled within the same broad period.

612
00:42:21.128 --> 00:42:25.448
Comparing those totals provides an initial view of the resources and

613
00:42:25.448 --> 00:42:27.688
obligations associated with that period.

614
00:42:29.208 --> 00:42:32.028
Two common measures use those classified amounts.

615
00:42:33.448 --> 00:42:37.768
Working capital is current assets minus current liabilities.

616
00:42:38.768 --> 00:42:43.748
It measures the dollar amount by which current resources exceed, or fall short

617
00:42:43.748 --> 00:42:45.248
of, current obligations.

618
00:42:46.728 --> 00:42:52.048
A larger positive working-capital balance means current assets exceed current

619
00:42:52.048 --> 00:42:53.908
liabilities by more dollars.

620
00:42:55.428 --> 00:43:00.288
The current ratio is current assets divided by current liabilities.

621
00:43:01.248 --> 00:43:05.828
It expresses the amount of current assets relative to each dollar of current

622
00:43:05.828 --> 00:43:06.248
liabilities.

623
00:43:07.328 --> 00:43:11.768
Because it is a relative measure rather than a dollar amount, it can be more

624
00:43:11.768 --> 00:43:15.228
useful than working capital when comparing companies of different sizes.

625
00:43:16.188 --> 00:43:21.848
If current liabilities are zero, the ratio is undefined, so report the

626
00:43:21.848 --> 00:43:23.108
underlying amounts instead.

627
00:43:24.288 --> 00:43:28.428
The two measures provide different views of near-term financial position.

628
00:43:29.528 --> 00:43:33.528
Working capital shows the absolute difference between current assets and

629
00:43:33.528 --> 00:43:37.888
current liabilities, while the current ratio shows that relationship relative

630
00:43:37.888 --> 00:43:39.568
to the size of current liabilities.

631
00:43:40.928 --> 00:43:44.968
Neither measure establishes that cash will be available before every

632
00:43:44.968 --> 00:43:45.988
obligation is due.

633
00:43:46.928 --> 00:43:51.048
Current assets include resources with different degrees of liquidity, and

634
00:43:51.048 --> 00:43:53.648
current liabilities may have different settlement dates.

635
00:43:54.746 --> 00:44:01.246
Use working capital and the current ratio as starting points, then examine the

636
00:44:01.246 --> 00:44:05.266
composition and timing of the underlying assets and obligations.

637
00:44:06.386 --> 00:44:11.866
For both calculations, use current assets and current liabilities measured at

638
00:44:11.866 --> 00:44:13.266
the same reporting date.

639
00:44:14.266 --> 00:44:17.046
Using Millbrook's reported current subtotals:

640
00:44:18.370 --> 00:44:24.710
Working capital equals current assets minus current liabilities.

641
00:44:25.990 --> 00:44:36.930
For Millbrook, 480,000 dollars minus 400,000 dollars is 80,000 dollars.

642
00:44:36.930 --> 00:44:44.650
The current ratio equals current assets divided by current liabilities.

643
00:44:44.650 --> 00:44:56.741
For Millbrook, 480,000 dollars divided by 400,000 dollars is 1.20.

644
00:44:58.241 --> 00:45:04.121
Millbrook's current assets are 1.20 times its current liabilities,

645
00:45:05.021 --> 00:45:10.301
and Millbrook has 80,000 dollars more current assets than current liabilities.

646
00:45:11.251 --> 00:45:17.481
The working-capital balance of 80,000 dollars is not money held in a separate

647
00:45:17.481 --> 00:45:23.961
account, and Millbrook has only 90,000 dollars of operating cash at this date.

648
00:45:25.021 --> 00:45:29.081
Asset composition at the same current ratio.

649
00:45:30.521 --> 00:45:34.921
Equal current ratios can conceal different kinds of current assets.

650
00:45:36.261 --> 00:45:39.121
Cash available for operations can be spent immediately.

651
00:45:40.481 --> 00:45:46.061
Receivables must be collected, and inventory normally must be sold and, if

652
00:45:46.061 --> 00:45:49.281
sold on credit, the resulting receivable collected.

653
00:45:50.441 --> 00:45:54.601
A prepayment provides a service benefit rather than spendable cash.

654
00:45:55.861 --> 00:46:00.441
Equal current-asset totals therefore do not make the underlying resources

655
00:46:00.441 --> 00:46:02.281
equally available for payment.

656
00:46:03.761 --> 00:46:07.781
Consider a separate January 5, 2027 transaction.

657
00:46:08.941 --> 00:46:14.461
Starting from its December 31 balances, Millbrook purchases 60,000 dollars of

658
00:46:14.461 --> 00:46:16.861
ready-for-sale inventory for cash.

659
00:46:17.601 --> 00:46:19.261
No other balance changes.

660
00:46:20.343 --> 00:46:24.663
The table compares the balances before and after the purchase.

661
00:46:26.243 --> 00:46:31.803
Operating cash falls from 90,000 dollars to 30,000 dollars.

662
00:46:31.803 --> 00:46:36.603
Net receivables stay at 120,000 dollars.

663
00:46:36.603 --> 00:46:43.103
Inventory rises from 250,000 dollars to 310,000 dollars.

664
00:46:43.103 --> 00:46:45.523
Prepaid insurance stays at 20,000 dollars.

665
00:46:45.523 --> 00:46:52.363
Total current assets stay at 480,000 dollars, and total current liabilities

666
00:46:52.363 --> 00:46:55.203
stay at 400,000 dollars.

667
00:46:55.203 --> 00:47:00.663
The current ratio is 1.20 before and after the purchase.

668
00:47:01.831 --> 00:47:05.891
Millbrook now holds less cash and more inventory,

669
00:47:06.711 --> 00:47:11.351
but total current assets and current liabilities are unchanged.

670
00:47:12.671 --> 00:47:13.751
The current ratio

671
00:47:14.551 --> 00:47:18.291
therefore remains 1.20.

672
00:47:18.291 --> 00:47:22.191
The cash immediately available for a payment has changed.

673
00:47:23.731 --> 00:47:29.891
Millbrook replaced 60,000 dollars of cash with inventory that it must first

674
00:47:29.891 --> 00:47:36.591
sell and, if sold on credit, collect before the amount becomes cash available

675
00:47:36.591 --> 00:47:37.441
for payment.

676
00:47:38.931 --> 00:47:43.931
Assessing liquidity therefore requires information about the composition of

677
00:47:43.931 --> 00:47:47.871
current assets as well as the timing of expected sales,

678
00:47:48.891 --> 00:47:50.361
collections, and obligations.

679
00:47:52.125 --> 00:47:54.086
Effects of a payable payment.

680
00:47:55.245 --> 00:48:00.605
A cash payment of a current payable reduces current assets and current

681
00:48:00.605 --> 00:48:02.245
liabilities by the same amount.

682
00:48:03.186 --> 00:48:07.905
Their dollar difference, working capital, therefore remains unchanged.

683
00:48:08.625 --> 00:48:13.445
The current ratio can change, however, because the same dollar reduction

684
00:48:13.445 --> 00:48:17.246
affects the numerator and denominator by different percentages.

685
00:48:17.945 --> 00:48:23.666
When current assets exceed current liabilities, the payment removes a larger

686
00:48:23.666 --> 00:48:28.285
percentage of current liabilities than of current assets, so the current ratio

687
00:48:28.285 --> 00:48:28.846
rises.

688
00:48:29.666 --> 00:48:34.706
When current assets are less than current liabilities, the opposite occurs and

689
00:48:34.706 --> 00:48:35.706
the ratio falls.

690
00:48:36.466 --> 00:48:41.745
If current assets and current liabilities begin equal, an equal reduction

691
00:48:41.745 --> 00:48:43.725
leaves the ratio unchanged.

692
00:48:44.346 --> 00:48:49.366
These conclusions assume that current liabilities remain above zero so that

693
00:48:49.366 --> 00:48:50.966
the ratio is still defined.

694
00:48:52.425 --> 00:48:57.026
Do not interpret a change in the current ratio without first identifying which

695
00:48:57.026 --> 00:48:58.066
accounts changed.

696
00:48:58.986 --> 00:49:04.185
A higher current ratio may result from an increase in cash or receivables, but

697
00:49:04.185 --> 00:49:08.945
it may also result from an increase in inventory or from paying down current

698
00:49:08.945 --> 00:49:09.465
liabilities.

699
00:49:10.465 --> 00:49:14.746
Those changes do not have the same effect on near-term payment capacity.

700
00:49:15.585 --> 00:49:17.346
After calculating the ratio,

701
00:49:18.166 --> 00:49:22.426
examine the composition of the remaining current assets and the timing and

702
00:49:22.426 --> 00:49:26.725
amount of the remaining current liabilities before drawing a conclusion about

703
00:49:26.725 --> 00:49:27.066
liquidity.

704
00:49:28.075 --> 00:49:34.645
In a separate January 5, 2027 alternative, Millbrook pays 20,000 dollars of

705
00:49:34.645 --> 00:49:36.706
accounts payable with operating cash.

706
00:49:38.066 --> 00:49:42.286
Start again from the December 31 balances, before the inventory purchase

707
00:49:42.286 --> 00:49:43.045
described above.

708
00:49:43.045 --> 00:49:45.365
No other balance changes.

709
00:49:46.415 --> 00:49:51.426
The table compares the balances before and after the payment.

710
00:49:52.816 --> 00:49:58.955
Operating cash falls from 90,000 dollars to 70,000 dollars.

711
00:49:58.955 --> 00:50:06.456
Current assets fall from 480,000 dollars to 460,000 dollars.

712
00:50:06.456 --> 00:50:13.186
Current liabilities fall from 400,000 dollars to 380,000 dollars.

713
00:50:13.186 --> 00:50:17.276
Working capital stays at 80,000 dollars.

714
00:50:17.276 --> 00:50:24.079
The current ratio rises from 1.20 to 1.21.

715
00:50:24.779 --> 00:50:31.439
Both current assets and current liabilities decrease by 20,000 dollars, so

716
00:50:31.439 --> 00:50:34.819
working capital remains 80,000 dollars.

717
00:50:34.819 --> 00:50:41.579
The current ratio rises because the reduction of 20,000 dollars represents a

718
00:50:41.579 --> 00:50:45.139
larger percentage of current liabilities than of current assets.

719
00:50:45.799 --> 00:50:56.319
The new ratio is 460,000 dollars divided by 380,000 dollars, rounded to 1.21.

720
00:50:56.319 --> 00:51:00.739
Millbrook now has less cash but also fewer unpaid obligations.

721
00:51:01.499 --> 00:51:06.659
The higher current ratio alone does not establish improved payment capacity,

722
00:51:07.059 --> 00:51:10.999
just as the decrease in cash alone does not establish deterioration.

723
00:51:12.179 --> 00:51:15.979
Assessing liquidity requires considering the remaining resources and

724
00:51:15.979 --> 00:51:17.119
obligations together.

725
00:51:17.939 --> 00:51:18.959
Check your understanding.

726
00:51:19.519 --> 00:51:24.619
If Millbrook reports more inventory next month and other current balances stay

727
00:51:24.619 --> 00:51:27.459
unchanged, the current ratio will rise.

728
00:51:28.279 --> 00:51:30.979
What would you need to know before calling that an improvement?

729
00:51:32.119 --> 00:51:33.729
Pause to consider your answer.

730
00:51:34.599 --> 00:51:35.859
Here is the explanation.

731
00:51:37.039 --> 00:51:40.979
Determine whether the inventory is saleable and when Millbrook expects to sell

732
00:51:40.979 --> 00:51:41.949
and collect.

733
00:51:42.639 --> 00:51:47.059
Additional inventory may support planned sales, or it may remain unsold.

734
00:51:47.579 --> 00:51:52.299
Its inclusion in current assets does not establish the quality or timing of

735
00:51:52.299 --> 00:51:53.299
future cash collections.

736
00:51:55.253 --> 00:51:57.714
Comparability of reported amounts.

737
00:51:59.373 --> 00:52:00.473
Comparable reported amounts.

738
00:52:01.973 --> 00:52:06.394
Before interpreting a change, first make sure the amounts are actually

739
00:52:06.394 --> 00:52:06.934
comparable.

740
00:52:07.913 --> 00:52:12.213
A reported amount can appear different because the underlying balance changed,

741
00:52:12.813 --> 00:52:17.294
because the company changed how accounts are grouped or presented, or because

742
00:52:17.294 --> 00:52:19.233
the measurement of the accounts changed.

743
00:52:20.364 --> 00:52:25.393
In comparative financial statements, companies present prior-period amounts on

744
00:52:25.393 --> 00:52:26.653
a comparable basis.

745
00:52:27.954 --> 00:52:33.513
When a presentation change or reclassification affects comparability, A S C

746
00:52:33.513 --> 00:52:43.494
Topic 205, Subtopic 10, Section 45, paragraph 3 and A S C Topic 205, Subtopic

747
00:52:43.494 --> 00:52:49.454
10, Section 50, paragraph 1 require the company to explain the change.

748
00:52:50.814 --> 00:52:55.733
Analysts may still need to examine the statement and notes to identify exactly

749
00:52:55.733 --> 00:52:58.413
which accounts are included in a reported caption.

750
00:53:00.054 --> 00:53:03.173
Start by identifying what each reported amount includes.

751
00:53:04.654 --> 00:53:09.353
Compare the same component in each period, or combine the same components into

752
00:53:09.353 --> 00:53:12.133
a common total when the available information permits.

753
00:53:13.273 --> 00:53:18.614
If the necessary detail is unavailable, state that limitation rather than

754
00:53:18.614 --> 00:53:20.384
treating unlike amounts as equivalent.

755
00:53:21.573 --> 00:53:25.673
After the account groupings are aligned, consider whether the amounts were

756
00:53:25.673 --> 00:53:27.114
measured on a comparable basis.

757
00:53:27.813 --> 00:53:32.673
For example, a higher allowance for expected credit losses can reduce net

758
00:53:32.673 --> 00:53:36.154
receivables even when customers' unpaid balances have not changed.

759
00:53:37.654 --> 00:53:41.253
Changes in depreciation estimates can similarly affect reported carrying

760
00:53:41.253 --> 00:53:44.414
amounts without a purchase or sale of the underlying assets.

761
00:53:45.713 --> 00:53:48.234
A useful comparison requires two checks:

762
00:53:49.133 --> 00:53:51.393
Are the same underlying accounts included?

763
00:53:52.273 --> 00:53:54.593
Are those accounts measured on a comparable basis?

764
00:53:56.133 --> 00:54:00.093
Consider two presentations of Millbrook's December 31 cash balances.

765
00:54:01.213 --> 00:54:06.593
A combined caption of 150,000 dollars would include 90,000 dollars available

766
00:54:06.593 --> 00:54:11.074
for operations and 60,000 dollars restricted for workshop construction.

767
00:54:12.145 --> 00:54:17.565
Millbrook's classified balance sheet reports those amounts separately because

768
00:54:17.565 --> 00:54:18.865
their uses differ.

769
00:54:20.405 --> 00:54:25.545
Comparing the combined amount of 150,000 dollars with the separate

770
00:54:25.545 --> 00:54:31.765
operating-cash caption of 90,000 dollars would appear to show a decrease of

771
00:54:31.765 --> 00:54:37.245
60,000 dollars even though the underlying cash balances are identical.

772
00:54:38.425 --> 00:54:44.265
To compare cash available for operations, use 90,000 dollars in both

773
00:54:44.265 --> 00:54:44.965
presentations.

774
00:54:45.905 --> 00:54:51.245
To compare total reported cash, combine the operating and restricted amounts

775
00:54:51.245 --> 00:54:52.565
in both periods.

776
00:54:53.365 --> 00:54:56.215
The grouping changed; no cash was spent.

777
00:54:57.705 --> 00:54:58.585
Check your understanding.

778
00:54:59.845 --> 00:55:04.585
Suppose an earlier statement gives only a combined cash amount and no

779
00:55:04.585 --> 00:55:05.915
breakdown of restrictions.

780
00:55:06.565 --> 00:55:10.125
Can you calculate the change in cash available for operations?

781
00:55:11.285 --> 00:55:13.175
Pause to consider your answer.

782
00:55:14.445 --> 00:55:15.325
Here is the explanation.

783
00:55:16.465 --> 00:55:16.685
No.

784
00:55:17.025 --> 00:55:19.865
You lack the earlier operating cash amount.

785
00:55:21.005 --> 00:55:25.005
Report that limit rather than assume all cash was available for operations.

786
00:55:26.998 --> 00:55:29.718
Horizontal and common-size comparisons.

787
00:55:30.878 --> 00:55:33.848
A balance sheet reports a snapshot at a date.

788
00:55:35.038 --> 00:55:39.318
Comparing balance sheets from two dates shows how reported financial position

789
00:55:39.318 --> 00:55:41.338
changed between those snapshots.

790
00:55:41.898 --> 00:55:45.458
It does not, by itself, show what caused the change.

791
00:55:46.278 --> 00:55:48.078
The company's other financial statements,

792
00:55:48.978 --> 00:55:52.578
notes, and additional business information may be needed to explain it.

793
00:55:53.538 --> 00:55:56.838
After matching the underlying accounts and measurement basis,

794
00:55:58.018 --> 00:56:01.998
horizontal and common-size analysis help describe the reported change.

795
00:56:03.938 --> 00:56:07.788
Horizontal analysis compares an amount between periods or dates.

796
00:56:08.738 --> 00:56:10.378
First calculate the dollar change.

797
00:56:10.978 --> 00:56:15.698
Then divide that change by the earlier amount to express the change as a

798
00:56:15.698 --> 00:56:17.298
percentage of the earlier balance.

799
00:56:18.078 --> 00:56:23.518
If the earlier amount is zero, the percentage change is undefined; report and

800
00:56:23.518 --> 00:56:25.818
describe the dollar change instead.

801
00:56:25.818 --> 00:56:31.698
Common-size analysis expresses each balance-sheet amount as a percentage of

802
00:56:31.698 --> 00:56:33.418
total assets at the same date.

803
00:56:34.418 --> 00:56:37.478
This includes assets, liabilities, and equity accounts.

804
00:56:38.578 --> 00:56:42.878
It shows the composition of reported financial position and can help compare

805
00:56:42.878 --> 00:56:44.338
entities of different sizes.

806
00:56:44.338 --> 00:56:49.718
Common-size analysis can also be applied to other financial statements using

807
00:56:49.718 --> 00:56:53.538
an appropriate base amount, such as revenue for income-statement amounts.

808
00:56:54.538 --> 00:56:57.018
The two methods answer different questions.

809
00:56:58.258 --> 00:57:02.778
Horizontal analysis asks how much an amount changed relative to its own

810
00:57:02.778 --> 00:57:03.318
starting amount.

811
00:57:03.318 --> 00:57:08.898
Common-size analysis asks what portion of total reported assets the amount

812
00:57:08.898 --> 00:57:09.478
represents.

813
00:57:10.338 --> 00:57:15.078
An account can increase in dollars while declining as a percentage of total

814
00:57:15.078 --> 00:57:17.378
assets if total assets grow faster.

815
00:57:18.378 --> 00:57:22.378
Choose the denominator that matches the question rather than treating the

816
00:57:22.378 --> 00:57:24.658
resulting percentages as interchangeable.

817
00:57:25.178 --> 00:57:29.418
A change between two common-size percentages is expressed in percentage

818
00:57:29.418 --> 00:57:29.958
points,

819
00:57:31.018 --> 00:57:33.648
calculated as the arithmetic difference between the percentages.

820
00:57:34.733 --> 00:57:39.393
That change is different from the percentage growth of the underlying account.

821
00:57:40.473 --> 00:57:44.393
Both forms of analysis still reflect the effects of recognition,

822
00:57:45.593 --> 00:57:47.973
measurement, estimates, and business activity.

823
00:57:49.273 --> 00:57:54.293
Expressing an amount as a percentage does not by itself explain why the amount

824
00:57:54.293 --> 00:57:54.813
changed.

825
00:57:56.253 --> 00:58:02.063
Millbrook's inventory increased from 200,000 dollars in 2025 to 250,000

826
00:58:02.063 --> 00:58:04.213
dollars in 2026.

827
00:58:04.733 --> 00:58:12.513
Its total assets increased from 1,100,000 dollars to 1,200,000 dollars.

828
00:58:12.513 --> 00:58:18.013
These year-end amounts precede the separate January inventory-purchase and

829
00:58:18.013 --> 00:58:19.393
payable-payment alternatives.

830
00:58:20.526 --> 00:58:29.056
Inventory rose from 200,000 dollars to 250,000 dollars, a change of 50,000

831
00:58:29.056 --> 00:58:30.306
dollars.

832
00:58:30.306 --> 00:58:37.727
Divide 50,000 dollars by 200,000 dollars, and the percentage change is 25

833
00:58:37.727 --> 00:58:38.136
percent.

834
00:58:38.836 --> 00:58:40.396
Inventory comparison,

835
00:58:41.516 --> 00:58:42.576
Inventory;

836
00:58:43.476 --> 00:58:54.976
2025, 200,000 dollars; 2026, 250,000 dollars.

837
00:58:54.976 --> 00:58:55.936
Inventory comparison,

838
00:58:57.336 --> 00:58:58.296
Total assets;

839
00:58:59.936 --> 00:59:11.956
2025, 1,100,000; 2026, 1,200,000.

840
00:59:11.956 --> 00:59:12.576
Inventory comparison,

841
00:59:14.236 --> 00:59:16.816
Inventory as a percentage of total assets;

842
00:59:18.356 --> 00:59:28.010
2025, 18.18 percent; 2026, 20.83 percent.

843
00:59:28.710 --> 00:59:34.790
Inventory increased by 25 percent from 2025 to 2026.

844
00:59:35.520 --> 00:59:40.950
That horizontal-analysis result shows how much the inventory balance grew

845
00:59:40.950 --> 00:59:43.630
relative to its own 2025 amount.

846
00:59:44.630 --> 00:59:52.110
Over the same period, inventory increased from 18.18 percent to 20.83 percent

847
00:59:52.110 --> 00:59:57.130
of total assets, an increase of 2.65 percentage points.

848
00:59:57.880 --> 01:00:03.250
The common-size comparison shows that inventory also became a larger part of

849
01:00:03.250 --> 01:00:05.010
Millbrook's reported asset base.

850
01:00:06.090 --> 01:00:10.010
The calculations use different denominators and answer different questions.

851
01:00:10.930 --> 01:00:17.010
The 25 percent increase uses 2025 inventory as the denominator and measures

852
01:00:17.010 --> 01:00:19.490
growth in the inventory account itself.

853
01:00:20.230 --> 01:00:25.170
The common-size percentages use total assets at each year-end and measure

854
01:00:25.170 --> 01:00:28.230
inventory's share of the company's reported resources.

855
01:00:29.310 --> 01:00:31.430
Because inventory's share increased,

856
01:00:32.290 --> 01:00:35.010
inventory grew faster than total assets overall.

857
01:00:35.790 --> 01:00:39.830
That result identifies inventory as an amount that may warrant further

858
01:00:39.830 --> 01:00:44.070
investigation, but neither calculation explains why it increased.

859
01:00:45.250 --> 01:00:50.270
Millbrook may be building inventory in anticipation of higher sales, or it may

860
01:00:50.270 --> 01:00:53.180
be accumulating products that are becoming harder to sell.

861
01:00:53.970 --> 01:00:57.930
Answering that question requires additional information about the business and

862
01:00:57.930 --> 01:00:58.710
its operations.

863
01:00:59.910 --> 01:01:03.650
The calculations also retain the effects of the accounting policies and

864
01:01:03.650 --> 01:01:05.990
estimates used to measure the underlying balances.

865
01:01:07.170 --> 01:01:11.240
Converting carrying amounts to percentages makes amounts easier to compare,

866
01:01:11.530 --> 01:01:15.630
but it does not eliminate differences in how those amounts were recognized or

867
01:01:15.630 --> 01:01:15.850
measured.

868
01:01:16.310 --> 01:01:21.690
In Chapter 18, we will use inventory turnover, which relates cost of goods

869
01:01:21.690 --> 01:01:26.230
sold to average inventory, to examine how inventory moves through the

870
01:01:26.230 --> 01:01:26.470
business.

871
01:01:27.605 --> 01:01:32.785
The written chapter links to the section of Chapter 6 on comparing income

872
01:01:32.785 --> 01:01:34.205
statements across years.

873
01:01:34.965 --> 01:01:39.425
That section applies the same dollar and percentage comparison to

874
01:01:39.425 --> 01:01:40.425
income-statement amounts.

875
01:01:42.372 --> 01:01:45.912
Average balances and period activity.

876
01:01:47.432 --> 01:01:53.272
An income-statement amount measures activity over a period, while a

877
01:01:53.272 --> 01:01:58.492
balance-sheet amount measures resources or obligations at a particular date.

878
01:01:59.512 --> 01:02:04.932
When a comparison relates period activity to resources used during that

879
01:02:04.932 --> 01:02:10.332
period, the ending balance may not represent the amount held throughout the

880
01:02:10.332 --> 01:02:10.552
period.

881
01:02:11.312 --> 01:02:16.932
An average balance combines observations from the period to estimate a

882
01:02:16.932 --> 01:02:17.972
representative amount.

883
01:02:19.232 --> 01:02:23.342
Add the observed balances and divide by the number of observations.

884
01:02:24.572 --> 01:02:29.352
Using only beginning and ending balances gives equal weight to those two

885
01:02:29.352 --> 01:02:29.372
dates.

886
01:02:30.392 --> 01:02:34.852
This approach is convenient when only annual statements are available, but it

887
01:02:34.852 --> 01:02:38.832
does not capture increases or decreases that occur between them.

888
01:02:39.612 --> 01:02:44.852
The choice and timing of observations matter when balances fluctuate during

889
01:02:44.852 --> 01:02:45.632
the year.

890
01:02:46.312 --> 01:02:51.552
More frequent, regularly spaced observations may better reflect seasonal or

891
01:02:51.552 --> 01:02:52.912
other temporary changes.

892
01:02:53.712 --> 01:02:58.572
The resulting average is still only an approximation of the balance held

893
01:02:58.572 --> 01:02:59.622
throughout the period.

894
01:03:00.692 --> 01:03:05.312
Use observations that reasonably represent the period being analyzed, and

895
01:03:05.312 --> 01:03:08.352
explain the approximation when it could affect the conclusion.

896
01:03:09.832 --> 01:03:12.102
Not every comparison calls for an average.

897
01:03:13.072 --> 01:03:17.712
Some analyses ask about financial position at a specific date rather than

898
01:03:17.712 --> 01:03:20.262
about resources used over a period.

899
01:03:20.532 --> 01:03:25.712
For example, the current ratio compares current assets with current

900
01:03:25.712 --> 01:03:30.032
liabilities at the same reporting date because it measures the relationship

901
01:03:30.032 --> 01:03:32.752
between those amounts at that point in time.

902
01:03:33.452 --> 01:03:37.152
Replacing either amount with an average would answer a different question.

903
01:03:38.512 --> 01:03:43.412
Use an average balance when the analysis relates activity occurring over a

904
01:03:43.412 --> 01:03:47.272
period to resources or obligations held during that period.

905
01:03:48.412 --> 01:03:53.112
The goal is to estimate an amount that is more representative of the period

906
01:03:53.112 --> 01:03:56.132
than a single beginning or ending balance.

907
01:03:56.952 --> 01:04:01.232
Do not use an average simply because a balance-sheet amount appears in the

908
01:04:01.232 --> 01:04:01.712
calculation.

909
01:04:02.752 --> 01:04:06.992
A common approximation uses the beginning and ending balances.

910
01:04:08.512 --> 01:04:13.852
Suppose Millbrook begins the year with 200,000 dollars of inventory and ends

911
01:04:13.852 --> 01:04:16.215
with 250,000 dollars:

912
01:04:16.915 --> 01:04:24.795
The beginning-and-ending average adds 200,000 dollars and 250,000 dollars and

913
01:04:24.795 --> 01:04:26.775
divides by 2.

914
01:04:26.775 --> 01:04:30.930
The average is 225,000 dollars.

915
01:04:31.630 --> 01:04:37.310
This average incorporates more information than the ending balance alone, but

916
01:04:37.310 --> 01:04:41.350
it still cannot show what happened between the two observations.

917
01:04:42.790 --> 01:04:48.503
Suppose Millbrook's quarter-end inventory balances were 320,000 dollars,

918
01:04:48.503 --> 01:04:55.730
360,000 dollars, 300,000 dollars, and 250,000 dollars.

919
01:04:55.730 --> 01:05:01.510
Those observations suggest that Millbrook carried substantially more inventory

920
01:05:01.510 --> 01:05:05.230
during much of the year than the ending balance alone would indicate.

921
01:05:06.350 --> 01:05:14.563
The average of the four quarter-end observations adds 320,000, 360,000,

922
01:05:14.563 --> 01:05:21.730
300,000, and 250,000 dollars and divides by 4.

923
01:05:21.730 --> 01:05:26.679
The average is 307,500 dollars.

924
01:05:27.379 --> 01:05:34.439
The amount of 307,500 dollars is an average of the four quarter-end

925
01:05:34.439 --> 01:05:37.819
observations, not an exact daily average.

926
01:05:38.639 --> 01:05:43.139
More frequent observations may provide a better approximation when balances

927
01:05:43.139 --> 01:05:45.179
vary substantially during the year.

928
01:05:46.459 --> 01:05:50.419
Choose the balance measure that fits the question, and explain the

929
01:05:50.419 --> 01:05:52.169
approximation when it matters.

930
01:05:52.919 --> 01:05:54.579
Check your understanding.

931
01:05:55.699 --> 01:06:00.359
Should we average current assets when calculating Millbrook's current ratio at

932
01:06:00.359 --> 01:06:01.059
December 31?

933
01:06:02.659 --> 01:06:04.529
Pause to consider your answer.

934
01:06:05.739 --> 01:06:06.699
Here is the explanation.

935
01:06:06.699 --> 01:06:09.659
No.

936
01:06:09.659 --> 01:06:14.519
That ratio compares current assets and current liabilities at the same date.

937
01:06:15.879 --> 01:06:19.799
Averaging is useful when the question concerns resources held over a period;

938
01:06:19.799 --> 01:06:23.919
it is not an automatic improvement to every calculation.

939
01:06:25.926 --> 01:06:27.346
Independent practice.

940
01:06:27.346 --> 01:06:30.846
Clearwater's resources and obligations.

941
01:06:30.846 --> 01:06:36.926
Clearwater Commercial Cleaning provides recurring office cleaning under

942
01:06:36.926 --> 01:06:37.946
monthly contracts.

943
01:06:38.886 --> 01:06:42.506
Its normal operating cycle is shorter than one year.

944
01:06:43.406 --> 01:06:48.146
Employees use cleaning supplies, floor machines, and vans to provide services.

945
01:06:48.686 --> 01:06:53.666
The supplies are consumed as services are provided, while the floor machines

946
01:06:53.666 --> 01:06:56.866
and vans are used through repeated service periods.

947
01:06:58.066 --> 01:07:03.386
The following adjusted account balances are available at December 31, 2026.

948
01:07:04.446 --> 01:07:08.426
Interest has been paid through that date, and no borrowing condition changes

949
01:07:08.426 --> 01:07:10.006
the scheduled principal payments.

950
01:07:11.328 --> 01:07:13.388
Item, Operating cash;

951
01:07:14.408 --> 01:07:17.988
Amount, 35,000 dollars; Additional fact,

952
01:07:18.788 --> 01:07:21.048
Clearwater can use it for current operations.

953
01:07:22.268 --> 01:07:24.788
Item, Trade receivables, net;

954
01:07:25.808 --> 01:07:31.888
Amount, 50,000; Additional fact, Clearwater expects to collect the receivables

955
01:07:31.888 --> 01:07:33.408
during 2027.

956
01:07:34.588 --> 01:07:34.728
Item,

957
01:07:35.708 --> 01:07:36.188
Cleaning supplies;

958
01:07:37.168 --> 01:07:43.068
Amount, 10,000; Additional fact, Employees will consume them while providing

959
01:07:43.068 --> 01:07:45.588
cleaning services during 2027.

960
01:07:46.448 --> 01:07:48.368
Item, Prepaid insurance;

961
01:07:49.208 --> 01:07:55.348
Amount, 5,000; Additional fact, All coverage applies to 2027.

962
01:07:56.528 --> 01:07:56.648
Item,

963
01:07:57.648 --> 01:07:59.208
Equipment and vehicles, net;

964
01:08:00.188 --> 01:08:06.588
Amount, 180,000; Additional fact, Includes floor machines and vans used

965
01:08:06.588 --> 01:08:08.348
through repeated service periods.

966
01:08:09.428 --> 01:08:16.848
Item, Restricted cash; Amount, 20,000; Additional fact, A contract restricts

967
01:08:16.848 --> 01:08:19.088
it to vehicle purchases in 2028.

968
01:08:20.208 --> 01:08:20.508
Item,

969
01:08:21.308 --> 01:08:28.108
Accounts payable; Amount, 10,000; Additional fact, Payment is due during 2027.

970
01:08:29.248 --> 01:08:29.348
Item,

971
01:08:30.328 --> 01:08:36.588
Wages payable; Amount, 12,000; Additional fact, Employees are owed payment for

972
01:08:36.588 --> 01:08:37.728
December work.

973
01:08:38.328 --> 01:08:45.048
Item, Payroll amounts owed to authorities; Amount, 2,400; Additional fact,

974
01:08:45.728 --> 01:08:47.548
Payment is due during 2027.

975
01:08:48.648 --> 01:08:48.748
Item,

976
01:08:49.568 --> 01:08:54.088
Earned vacation payable; Amount, 6,000; Additional fact,

977
01:08:55.088 --> 01:08:58.068
Employees are expected to use the earned leave during 2027.

978
01:08:59.168 --> 01:08:59.388
Item,

979
01:09:00.268 --> 01:09:05.948
Customer advances; Amount, 8,000; Additional fact, Clearwater will provide the

980
01:09:05.948 --> 01:09:08.788
related cleaning services in January 2027.

981
01:09:09.728 --> 01:09:09.968
Item,

982
01:09:11.048 --> 01:09:16.328
Utilities payable; Amount, 1,600; Additional fact, Payment for services

983
01:09:16.328 --> 01:09:18.888
already received is due during 2027.

984
01:09:19.968 --> 01:09:20.048
Item,

985
01:09:20.848 --> 01:09:21.268
Loan principal;

986
01:09:22.088 --> 01:09:28.618
Amount, 80,000; Additional fact, 10,000 dollars is due during 2027 and 70,000

987
01:09:28.618 --> 01:09:29.968
dollars is due later.

988
01:09:31.010 --> 01:09:37.510
Classify each item, or portion of an item, as current or non-current.

989
01:09:37.510 --> 01:09:41.050
Then calculate current assets, current liabilities,

990
01:09:42.070 --> 01:09:44.530
working capital, and the current ratio.

991
01:09:46.010 --> 01:09:50.030
Explain why the cleaning supplies and equipment belong in different

992
01:09:50.030 --> 01:09:54.750
classification groups even though employees use both to provide cleaning

993
01:09:54.750 --> 01:09:55.270
services.

994
01:09:56.650 --> 01:09:58.300
Pause to consider your answer.

995
01:09:59.080 --> 01:10:00.730
Here is the explanation.

996
01:10:02.270 --> 01:10:05.850
Current assets are operating cash, net receivables,

997
01:10:06.850 --> 01:10:12.580
cleaning supplies, and prepaid insurance, for a total of 100,000 dollars:

998
01:10:12.580 --> 01:10:20.460
35,000 dollars, 50,000 dollars, 10,000 dollars, and 5,000 dollars.

999
01:10:20.460 --> 01:10:26.970
The 180,000 dollars of equipment and vehicles and 20,000 dollars of restricted

1000
01:10:26.970 --> 01:10:28.310
cash are non-current.

1001
01:10:28.310 --> 01:10:28.530
Current

1002
01:10:30.050 --> 01:10:37.070
operating liabilities total 40,000 dollars: 10,000 dollars, 12,000 dollars,

1003
01:10:37.070 --> 01:10:44.830
2,400 dollars, 6,000 dollars, 8,000 dollars, and 1,600 dollars.

1004
01:10:44.830 --> 01:10:49.670
Add the current loan portion of 10,000 dollars for total current liabilities

1005
01:10:49.670 --> 01:10:51.570
of 50,000 dollars.

1006
01:10:51.570 --> 01:10:57.010
The remaining 70,000 dollars of loan principal is non-current.

1007
01:10:57.010 --> 01:11:03.180
Working capital is 100,000 dollars minus 50,000 dollars, which equals 50,000

1008
01:11:03.180 --> 01:11:04.250
dollars.

1009
01:11:04.250 --> 01:11:09.910
The current ratio is 100,000 dollars divided by 50,000 dollars, which equals

1010
01:11:09.910 --> 01:11:11.730
2.

1011
01:11:11.730 --> 01:11:15.650
Employees consume the supplies during current service work, so those supplies

1012
01:11:15.650 --> 01:11:19.290
are current assets even though Clearwater does not sell them.

1013
01:11:19.890 --> 01:11:24.490
The floor machines remain in use through repeated service periods and are

1014
01:11:24.490 --> 01:11:25.660
non-current.

1015
01:11:25.660 --> 01:11:29.330
Revenue-producing use alone does not make an asset current.

1016
01:11:31.195 --> 01:11:35.855
What Clearwater's reported assets do and do not show.

1017
01:11:37.515 --> 01:11:43.835
Clearwater reports equipment and vehicles at a cost of 240,000 dollars less

1018
01:11:43.835 --> 01:11:50.575
accumulated depreciation of 60,000 dollars, for a carrying amount of 180,000

1019
01:11:50.575 --> 01:11:51.735
dollars.

1020
01:11:51.735 --> 01:11:53.935
Its owner makes two claims:

1021
01:11:55.295 --> 01:12:00.895
"The carrying amount of 180,000 dollars is what Clearwater would receive if it

1022
01:12:00.895 --> 01:12:02.975
sold the equipment and vehicles today.".

1023
01:12:04.735 --> 01:12:09.095
"Our employees' skills and loyal customers have value, so the accountant

1024
01:12:09.095 --> 01:12:12.195
should add estimated amounts for them to the balance sheet.".

1025
01:12:13.635 --> 01:12:17.495
Evaluate each claim using the accounting concepts from this chapter.

1026
01:12:18.875 --> 01:12:22.855
Explain what the reported balance-sheet information does and does not

1027
01:12:22.855 --> 01:12:23.375
establish.

1028
01:12:24.575 --> 01:12:25.965
Pause to consider your answer.

1029
01:12:26.555 --> 01:12:28.215
Here is the explanation.

1030
01:12:29.075 --> 01:12:35.015
The carrying amount of 180,000 dollars reflects Clearwater's accounting

1031
01:12:35.015 --> 01:12:37.015
measurement of its equipment and vehicles.

1032
01:12:37.855 --> 01:12:41.715
It does not establish what the company would receive if it sold those assets

1033
01:12:41.715 --> 01:12:42.315
today.

1034
01:12:43.395 --> 01:12:47.135
Estimating sale proceeds would require current market information about

1035
01:12:47.135 --> 01:12:51.715
comparable assets, the condition of Clearwater's equipment and vehicles, and

1036
01:12:51.715 --> 01:12:52.715
any selling costs.

1037
01:12:54.075 --> 01:12:58.815
Employees' skills and customer loyalty may contribute economic value without

1038
01:12:58.815 --> 01:13:01.235
appearing as separate assets on the balance sheet.

1039
01:13:02.015 --> 01:13:06.895
The fact that a resource is not separately reported does not establish that it

1040
01:13:06.895 --> 01:13:07.335
lacks value.

1041
01:13:08.095 --> 01:13:12.795
A reader cannot treat the absence of a reported asset as evidence that the

1042
01:13:12.795 --> 01:13:13.915
resource is worthless.

1043
01:13:15.881 --> 01:13:18.501
Clearwater's comparative receivables.

1044
01:13:20.041 --> 01:13:26.381
Clearwater's 2025 statement reported a single receivables caption of 50,000

1045
01:13:26.381 --> 01:13:32.781
dollars that included 45,000 dollars of net trade receivables from customers

1046
01:13:32.781 --> 01:13:37.381
and a receivable of 5,000 dollars from an employee loan.

1047
01:13:38.401 --> 01:13:43.301
The employee repaid the loan of 5,000 dollars during 2026.

1048
01:13:44.141 --> 01:13:50.481
Clearwater's 2026 statement reports 50,000 dollars of net trade receivables

1049
01:13:50.481 --> 01:13:53.241
and no employee-loan receivable.

1050
01:13:54.761 --> 01:13:58.681
Calculate the dollar and percentage change in net trade receivables.

1051
01:14:00.001 --> 01:14:04.901
Explain why comparing the two receivables captions of 50,000 dollars each

1052
01:14:04.901 --> 01:14:07.901
would not show the change in customer balances.

1053
01:14:09.741 --> 01:14:11.091
Pause to consider your answer.

1054
01:14:11.941 --> 01:14:13.361
Here is the explanation.

1055
01:14:14.941 --> 01:14:20.541
Net trade receivables increased by 5,000 dollars, which is 50,000 dollars

1056
01:14:20.541 --> 01:14:28.821
minus 45,000 dollars, or 11.11 percent, which is 5,000 dollars divided by

1057
01:14:28.821 --> 01:14:31.131
45,000 dollars.

1058
01:14:31.131 --> 01:14:37.081
The employee-loan receivable decreased from 5,000 dollars to zero when the

1059
01:14:37.081 --> 01:14:38.111
employee repaid the loan.

1060
01:14:38.761 --> 01:14:44.801
As a result, the total receivables caption remained 50,000 dollars even though

1061
01:14:44.801 --> 01:14:46.541
customer receivables increased.

1062
01:14:47.241 --> 01:14:52.741
The increase in net trade receivables does not, by itself, explain why

1063
01:14:52.741 --> 01:14:54.161
customer balances increased.

1064
01:14:55.161 --> 01:14:59.261
Clearwater may have made more sales on credit, collected receivables more

1065
01:14:59.261 --> 01:15:02.821
slowly, or changed its estimate of expected credit losses.

1066
01:15:03.821 --> 01:15:06.921
Additional information would be needed to distinguish among those

1067
01:15:06.921 --> 01:15:07.341
explanations.

1068
01:15:09.363 --> 01:15:14.023
Return to the written chapter for the Clearwater Commercial Cleaning problems.

1069
01:15:15.323 --> 01:15:17.853
Classify each resource and obligation,

1070
01:15:19.083 --> 01:15:23.903
evaluate the two claims about Clearwater's reported assets, and calculate the

1071
01:15:23.903 --> 01:15:25.843
change in net trade receivables.

1072
01:15:27.163 --> 01:15:31.233
Write each answer before you open the comparison on the page.