4.4: Classified Balance Sheet

• Contributed by Henry Dauderis and David Annand
• Athabasca University
• Sourced from Lyryx Learning

learning objective

LO2 – Explain and prepare a classified balance sheet.

The accounting cycle and double-entry accounting have been the focus of the preceding chapters. This chapter focuses on the presentation of financial statements, including how financial information is classified (the way accounts are grouped) and what is disclosed.

A common order for the presentation of financial statements is:

1. Income statement
2. Statement of changes in equity
3. Balance sheet
4. Statement of cash flows
5. Notes to the financial statements

In addition, the financial statements are often accompanied by an auditor's report and a statement entitled "Management's Responsibility for Financial Statements." Each of these items will be discussed below. Financial statement information must be disclosed for the most recent year with the prior year for comparison.

Because external users of financial statements have no access to the entity's accounting records, it is important that financial statements be organized in a manner that is easy to understand. Thus, financial data are grouped into useful, similar categories within classified financial statements, as discussed below.

The Classified Balance Sheet

A classified balance sheet organizes the asset and liability accounts into categories. The previous chapters used an unclassified balance sheet which included only three broad account groupings: assets, liabilities, and equity. The classification of asset and liability accounts into meaningful categories is designed to facilitate the analysis of balance sheet information by external users. Assets and liabilities are classified as either current or non-current. Another common term for non-current is long-term. Non-current assets, also referred to as long-term assets, can be classified further into long-term investments; property, plant and equipment; and intangible assets. The asset and liability classifications are summarized below:

 Assets Liabilities Non-current or long-term assets: Non-current or long-term liabilities Long-term investments Property, plant and equipment (PPE) Intangible assets

Current Assets

Current assets are those resources that the entity expects to convert to cash, or to consume during the next year or within the operating cycle of the entity, whichever is longer. Examples of current assets include:

• cash, comprising paper currency and coins, deposits at banks, cheques, and money orders.
• short-term investments, the investment of cash that will not be needed immediately, in short-term, interest-bearing notes that are easily convertible into cash.
• accounts receivable that are due to be collected within one year.
• notes receivable, usually formalized account receivables — written promises to pay specified amounts with interest, and due to be collected within one year.
• merchandise inventory that is expected to be sold within one year.

The current asset category also includes accounts whose future benefits are expected to expire in a short period of time. These are not expected to be converted into cash, and include:

• prepaid expenses that will expire within the next year, usually consisting of advance payments for insurance, rent, and other similar items.
• supplies on hand at the end of an accounting year that will be used during the next year.

On the balance sheet, current assets are normally reported before non-current assets. They are listed by decreasing levels of liquidity — their ability to be converted into cash. Therefore, cash appears first under the current asset heading since it is already liquid.

Non-current Assets

Non-current assets are assets that will be useful for more than one year; they are sometimes referred to as long-lived assets. Non-current assets include property, plant, and equipment (PPE) items used in the operations of the business. Some examples of PPE are: a) land, b) buildings, c) equipment, and d) motor vehicles such as trucks.

Other types of non-current assets include long-term investments and intangible assets. Long-term investments are held for more than one year or the operating cycle and include long-term notes receivable and investments in shares and bonds. Intangible assets are resources that do not have a physical form and whose value comes from the rights held by the owner. They are used over the long term to produce or sell products and services and include copyrights, patents, trademarks, and franchises.

Current Liabilities

Current liabilities are obligations that must be paid within the next 12 months or within the entity's next operating cycle, whichever is longer. They are shown first in the liabilities section of the balance sheet and listed in order of their due dates, with any bank loans shown first. Examples of current liabilities include:

• bank loans (or notes payable) that are payable on demand or due within the next 12 months
• accounts payable
• accrued liabilities such as interest payable and wages payable
• unearned revenue
• the current portion of long-term liabilities
• income taxes payable.

The current portion of a long-term liability is the principal amount of a long-term liability that is to be paid within the next 12 months. For example, assume a $24,000 note payable issued on January 1, 2015 where principal is repaid at the rate of$1,000 per month over two years. The current portion of this note on the January 31, 2015 balance sheet would be $12,000 (calculated as 12 months X$1,000/month). The remaining principal would be reported on the balance sheet as a long-term liability.

Non-Current or Long-Term Liabilities

Non-current liabilities, also referred to as long-term liabilities, are borrowings that do not require repayment for more than one year, such as the long-term portion of a bank loan or a mortgage. A mortgage is a liability that is secured by real estate.

Equity

The equity section of the classified balance sheet consists of two major accounts: share capital and retained earnings.

The following illustrates the presentation of Big Dog Carworks Corp.'s classified balance sheet after several years of operation.

Figure $$\PageIndex{1}$$

The balance sheet can be presented in the account form balance sheet, as shown above where liabilities and equities are presented to the right of the assets. An alternative is the report form balance sheet where liabilities and equity are presented below the assets.

The Classified Income Statement

Recall that the income statement summarizes a company's revenues less expenses over a period of time. An income statement for BDCC was presented in Chapter 1 as copied below.

 Big Dog Carworks Corp. Income Statement For the Month Ended January 31, 2015 Revenues Repair revenues $10,000 Expenses Rent expense$1,600 Salaries expense 3,500 Supplies expense 2,000 Fuel expense 700 Total expenses 7,800 Net income $2,200 The format used above was sufficient to disclose relevant financial information for Big Dog's simple start-up operations. Like the classified balance sheet, an income statement can be classified as well as prepared with comparative information. The classified income statement will be discussed in detail in Chapter 5. Regardless of the type of financial statement, any items that are material must be disclosed separately so users will not otherwise be misled. Materiality is a matter for judgment. Office supplies of$2,000 per month used by BDCC in January 2015 might be a material amount and therefore disclosed as a separate item on the income statement for the month ended January 31, 2015. If annual revenues grew to $1 million,$2,000 per month for supplies might be considered immaterial. These expenditures would then be grouped with other similar items and disclosed as a single amount.