Balance sheet assets are listed as accounts or items that are ordered by liquidity. Liquidity is the ease with which a firm can convert an asset into cash. The most liquid asset is cash (the first item on the balance sheet), followed by short-term deposits and accounts receivable. The most illiquid (not easily converted to cash) assets are listed further down on the balance sheet. These are assets such as land and buildings – often referred to as property, plant, and equipment (PP&E). On a balance sheet, assets are listed as either current assets (settled in cash in less than 12 months) or non-current assets (settled in cash in greater than 12 months).
#1 Current assets
Current balance sheet assets are expected to confer benefits in the near term, generally within 12 months. Cash, accounts receivable, prepaid expenses, and inventory are examples of current balance sheet assets.
Cash equivalents include cash held as bank deposits, short-term investments, and any other easily cash-convertible assets.
Accounts receivable are cash amounts that a company is owed as a vendor of goods or services. For example, a paper company may sell $100 of paper to a purchaser on credit. This $100 goes into accounts receivable for the paper company. An issue with receivables occurs when there are doubts that a debt will be paid. Accountants may need to write down the value of receivables and, in some instances, may even completely write off a receivables amount.
Inventory is a completed good a company owns that is ready for use/sale.
Inventory on the balance sheet for a company includes all costs of purchase, conversion, and other costs incurred in bringing inventory to its location. It includes the wages of production staff and overhead such as utilities or property rentals.
Receivables may require write-downs. In a similar vein, inventory can “go bad” from physical damage, deterioration, or obsolescence. The accounting treatment is the same – the balance sheet asset falls, with a corresponding expense in the income statement.
FIFO, LIFO, or weighted average?
Different organizations use different methods to account for the flow of inventory. Cost of sales in the income statement is the cost to the company of the goods sold in a given period. An organization must uniformly adhere to one system. The following example shows three possible treatments:
A sugar manufacturer buys 100 tons of unrefined sugar in April at $1,000/ton and a further 200 tons in September at $1,200/ton. In November, they sell 250 tons of refined sugar. What should the “cost of sales” number be?
The answer depends on how the flow of sugar is modeled through the process.
First In First Out (FIFO)
Cost of sales = (100 x 1,000) + (150 x 1,200) = $280,000
Last in First Out (LIFO)
Cost of sales = (200 x 1,200) + (50 x 1,000) = $290,000
Cost of sales = 250 x ((100 x 1,000) + (200 x 1,200)) / 300 = $283,334
The choice between FIFO, LIFO, and the Weighted Average method will be disclosed in the notes to financial statements. In IFRS, LIFO is permitted as a costing method. In US GAAP, any of the above cost methods are acceptable.
#2 Non-current assets
Non-current balance sheet assets are expected to confer benefits over a longer time horizon, generally longer than 12 months. Vehicles, plants, and machinery are examples of non-current balance sheet assets.
Tangible non-current assets
Tangible non-current assets are assets that have a physical existence. A tangible, non-current asset is, for example, be a company car, while an intangible, non-current asset is goodwill. If a long-term asset can be touched, it is tangible.
A tangible, non-current asset is measured at cost, meaning that on financial statements, its value is comprised of pieces including, but not limited to:
Initial delivery and handling
Installation and assembly
IFRS allows non-current assets to be measured through the cost model or the revaluation model. US GAAP only permits using the cost model.
Tangible, non-current assets are carried at cost less accumulated depreciation and any impairment loss.
Assets have a limited useful life (except for goodwill, land, and other infinitely useful assets) and are, thus, depreciated on the income statement. From the dual effect, depreciation will represent a decrease in value of the asset on the balance sheet and an increase in depreciation expense on the income statement. Two common depreciation methods are the straight-line method and accelerated depreciation.
In the straight-line depreciation method, an asset loses an equal proportion of its value every year throughout its useful life. In accelerated depreciation, a constant percentage charge of book value is charged each year, meaning that larger depreciation expenses are recorded early in its useful life. The choice of costing should reflect an asset’s useful life.
The revaluation model can only be used under IFRS. It is not an option under US GAAP. Under the revaluation model, an asset is recognized in the books of accounts, less its accumulated depreciation and impairment loss.
Capitalization of borrowing costs
Normally, borrowing costs are interest expenses on the income statement. However, if borrowing is used to buy or construct an asset, they must be capitalized in the value of the asset itself.
Intangible non-current assets
Intangible, non-current assets are without physical form and are typically contracts. Examples are patents, licenses, and goodwill.
Purchased intangibles, such the rights to explore for oil, are treated as tangible assets. They are on the balance sheet at cost and depreciated over their useful lives. IFRS allows the option to revalue purchased intangibles but US GAAP does not include this option.
Goodwill is a purchased intangible asset that arises when acquiring a company. It is the excess of the cost of the acquisition over the fair value of the identifiable net assets acquired. Goodwill is not amortized but the account must undergo a goodwill impairment test every year.
Internally generated intangibles
Reputation, knowledge, experience, and human capital are all examples of intangible assets that are generated internally rather than acquired. They are not recognized on the balance sheet. Any expenditure on developing these is expensed on the income statement.
Research and development
Research and development are always treated as an expense on the income statement. In IFRS, R&D costs are only capitalized in specific circumstances, while under US GAAP, they are generally expensed when they are incurred.
Amortization is depreciation for intangible assets. However, the terms depreciation and amortization are increasingly used interchangeably.
Impairment of Balance Sheet Assets
When balance sheet assets are carried at a higher value than the recoverable amount of the asset, the asset will need to be written down or impaired.
Impairment may be present if there is:
Current period operating loss
A significant decline in market value
Obsolescence or physical damage
Adverse business environment changes
Commitment to significant reorganization
The recoverable amount (RA) of an asset is the higher of its net realizable value (NRV) and its value in use (VIU). NRV is the selling price, less directs costs of selling the asset, while VIU is the present value of the future cash flows directly attributable to the asset.
Income statement impact of impairment losses
If any balance sheet assets are held at historical cost (purchase cost), any impairment loss is adjusted in the income statement. If the asset has been revalued upwards in the past, the impairment loss will reduce the revaluation reserve down to zero, with any additional impairment creating an income statement expense.
Circumstances indicate the impairment of a balance sheet asset, as outlined below. The details of the impairment review and test are outlined below:
This figure is exclusive to IFRS. In US GAAP, there is no impairment loss, as an asset is deemed not to be impaired if the sum of the future cash flows (undiscounted) is higher than the carrying value of the asset.
Reversals of impairment losses
Under IFRS, past impairments are reversed if, for whatever reason, an asset has become more valuable since its last evaluation. Under US GAAP, impairments are never reversed.
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