UNDERSTANDING ACCOUNTING TALK 8: Balance Sheet Assets
Assets (appearing in the Balance Sheet of a corporation, a small business, a household or a person), generally and commonly categorized into Current and Noncurrent, consist in: Cash, Cash Equivalents or Near Cash, Short Term Investments, Accounts Receivable & Allowance for Bad Debts (each of which were discussed in the previous blog), Notes Receivable, Interest Receivable, Inventories, Prepaid Expenses or Supplies.
Notes Receivable are written promises to pay at a fixed date and usually with interest. Interest Receivable represents the interest on a note receivable (stated in the promissory note) which has not yet been received. Inventories pertain to items already at hand and ready for sale by a corporation or a small business engaged in merchandising or manufacturing. The Balance Sheet of an individual or household will not have Inventories. Prepaid Expenses (as explained in post 7) are expenses paid in advance but not yet consumed or used (e.g., rent paid in advance, supplies, etc).
The Balance Sheet also lists Noncurrent Assets: Long Term Investments, Land, Building, Furniture and Fixtures, Equipment, Accumulated Depreciation, Intangible Assets. In Balance Sheets of small corporations and small businesses (also of an individual and household), there is no classification of assets into Current and Noncurrent and the Assets are listed all together.
Long Term Investments are investments with maturities that go beyond one year.
A physical asset (except Land) normally loses value from wear and tear. This loss in value is treated as an expense and booked in the Balance Sheet as Accumulated Depreciation. The Accumulated Depreciation reduces the value of the assets Building, Furniture & Fixtures, and Equipment.
There are several acceptable methods for computing Accumulated Depreciation: straight-line where the physical asset declines in equal values over its useful life, declining balance where the depreciation values are loaded on the early years of the life of the asset and decrease at a fixed rate during the later periods, variable declining balance where the depreciation values decrease at a variable rate. The formulae for these and other depreciation methods can be found in Excel.
Obviously, because Depreciation is an Expense, there are Income Tax implications. The declining balance methods load the heavier Expense on the early years of the Asset. For a start-up business (whether large corporation or small business), this can be a temporary tax-saving during the period when a business needs all of its cash to operate and grow.
Over the life of the physical asset, whatever depreciation method is used, the total Income Tax due will be the same because what was saved during the early years will be taken up during the later years when the Income Tax due will be greater (and the depreciation value correspondingly less). The declining balance methods endow the start-up business with relief from cash calls on its working capital while revenues have not yet built up, postponing the cash calls from Income Tax to the years when the revenues will have grown.
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POSTED IN: Accounting Concepts, Accounting for NonAccountants, Assets, Balance Sheets
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