The Balance Sheet: Assets, Liabilities, and Equity
The balance sheet is a point-in-time snapshot: Assets = Liabilities + Equity. Assets are classified as current (converted to cash or used within one year or the operating cycle, whichever is longer) or long-term (property, plant, equipment; intangibles; long-term investments). Liabilities follow the same current/long-term split. Equity for a corporation is contributed capital (common stock, additional paid-in capital) plus retained earnings (accumulated net income less dividends).
Valuation matters. Most receivables are reported at net realizable value (gross less allowance for doubtful accounts). Inventory is reported at the lower of cost or net realizable value (or lower of cost or market under older rules). PP&E is reported at cost less accumulated depreciation; land is not depreciated. Intangibles with finite lives are amortized; goodwill is tested for impairment, not amortized.
Traps: (1) Thinking the balance sheet shows market value-it mostly reflects historical cost. (2) Treating accumulated depreciation as an asset; it is a contra-asset that reduces book value. (3) Misclassifying a liability due within a year as long-term, or forgetting to reclassify a long-term note payable that is now due this year. (4) Confusing retained earnings with cash-retained earnings is an equity balance, not a bank balance. (5) Ignoring contingent liabilities that should be accrued when probable and estimable.
Worked example: A company has cash $40,000, accounts receivable $60,000 with a $5,000 allowance, inventory $50,000, equipment $200,000 with $80,000 accumulated depreciation, accounts payable $30,000, and a note payable due in 3 years $100,000. Total assets = 40,000 + 55,000 + 50,000 + 120,000 = $265,000. Total liabilities = $130,000. Equity = $135,000.