Hi, Else here.

And in this video, we'll be producing the balance sheet

under ASPE, accounting standards for private enterprises.

Recall that businesses that choose to use ASPE

must produce the following financial statements, income

statement, statement of retained earnings,

balance sheet, and the statement of cash flows.

We've already covered the income statement and the statement

of retained earnings in past videos, but let's just remind

ourselves of their structure.

The single step income statement shows the profitability

of a business over a period of time.

It always lists the revenues first

providing a subtotal if there's more than one type of revenue.

Next it lists all the expenses, again providing a subtotal.

Both the revenues and expenses are

listed in order of magnitude, from the largest

to the smallest.

Next, income before income tax, then income tax expense,

and finally net income.

Notice that the income tax expense is listed separately

from all the other expenses.

The net income at the bottom of the income statement

is then used in the statement of retained earnings.

This statement shows the profit retained, or kept,

in the business for future growth or expansion.

It starts with the retained earnings

balance from the prior year, adds the net income

from the current year, which is taken from the income

statement, then deducts any dividends declared or paid

to the owners before providing a closing retained earnings.

The closing retained earnings is then carried forward

to the balance sheet, which is the subject of this video.

The balance sheet summarizes the assets owned,

the liabilities owed, and the equity invested by the owners.

This statement shows the financial health

of a business at a specific point in time.

In order to understand the balance sheet,

we first have to understand the elements that

make up this statement.

Assets, liabilities, and equity, also

called shareholders' equity.

Each element has characteristics that define them.

When we record the activities of a business,

we use these characteristics to determine

if the transaction will affect that element or not.

Let's look at each element on that balance sheet

individually, starting with assets.

Assets have three characteristics,

assets are owned, they provide future economic benefit,

and they are due to past events.

Let's go through each of these characteristics

and expand on them.

First, assets are owned.

The concept of owned is pretty straightforward.

For example, my cell phone is an asset because I own it.

Second, assets provide future economic benefit.

That means that the assets will be used either directly

or indirectly to help the business.

The concept of future economic benefit is critical to assets.

What are future economic benefits for a business?

Well, an asset might be used to produce a good

or provide a service to customers,

like a machine that is used to manufacture potato chips,

or a lawnmower that's used to provide lawn care services.

It might mean that an asset may be used to get another asset,

like giving up cash in order to get a machine.

Or the business might be able to use the asset

to get rid of a liability, like paying down a loan with cash.

Assets must have future economic benefits for the business,

or they are not considered assets.

The last characteristic of assets

is that they are due to a past event.

That means that there was an event

in the past that transferred ownership of the asset

to the business.

Why is this last characteristic important?

Because it means that if I plan to purchase an asset

in the future, I cannot claim that it is an asset now,

because the event has not as yet happened.

It has to be a done deal.

The transfer of ownership must already have taken place.

So, to summarize, everything that a business owns

is considered an asset, a resource obtained

through a past event that will benefit

the business in the future.

Assets are defined as owned, providing

future economic benefit, and due to a past event.

On the balance sheet assets are divided into two categories,

current and long term.

Why?

Financial statements are all about communicating

useful information to decision makers.

By grouping assets based on their characteristics,

in this case how fast they are used are converted into cash,

stakeholders obtain a better understanding of the business

the financial position and health.

Let's define those two categories of assets.

Current assets are any assets that

will be converted into cash, sold,

or consumed within one year.

A few of the more common accounts found in this grouping

are things like cash and prepaid expenses.

Long term assets are any assets that

do not meet the definition of a current asset.

These are resources that will be converted into cash,

sold, or used over a period of more than one year.

They are divided into four subcategories, long term

investments, property plant and equipment, intangible assets,

and other assets.

In order to better understand the accounts that

go into current and long term assets,

I suggest you check out the financial statement elements

video which lists, defines, and describes

all the different accounts under each category.

How do companies get their assets?

They often use liabilities, the next element

of financial reporting.

They take on debt in order to increase their assets.

Liabilities also have three characteristics

that define them, liabilities are owed,

they will be settled in the future,

and finally liabilities are due to past events.

Again, let's go through each of these characteristics

individually.

First, liabilities are owed, an obligation or debt.

Important also is that they are owed

to third parties, individuals or groups who

are outside of the business.

A personal example of a liability

is the student loan you might owe as a debt to the bank.

Second, liabilities will be settled in the future.

How are they settled?

Through the giving up of either cash, goods, or services.

For instance, a student loan will

be settled through the payment of cash in the future,

but other obligations may be settled by providing a service

or delivering a good.

Third, liabilities are due to past events.

Again, why is this important?

Because if you plan to borrow money next year,

that's not a liability yet, and therefore you

can't record it as a liability.

That event, borrowing money, has not happened yet.

A liability will only exist after you get the money.

So, to summarize, everything that a company

owes to a third party is considered a liability,

an obligation due to a past event

that the business will settle in the future.

Liabilities are defined as owed to third parties

to be settled in the future due to a past event.

Like assets, liabilities are divided

into current and long term, again to provide information

to stakeholders so that they can make decisions.

Current liabilities are obligations that

will be settled in one year.

Current liabilities include accounts, such as accounts

payable, and unearned revenue.

Long term liabilities are debts which

are settled beyond one year.

Long term liabilities, unlike long term assets,

don't have any more subcategories.

All of the long term liabilities are simply listed together.

The accounts included in long term

almost always have the word payable as part of the account

name.

Again, to learn more, check out the financial statement

elements video, which lists, defines,

and describes all the different accounts under each category.

We've already defined the element, equity,

when you completed the statement of retained earnings.

As a reminder, equity is the financing by owners.

Recall that it is made up of contributed capital

and retained earnings.

It answers the question, what part of the business

is financed by the owners?

Similar to liabilities, the amount of equity

is owed to the owners by the business.

Just to expand on the two items that make up equity,

contributor capital is the direct investment

by the owners.

That means that the owners chose to contribute cash, goods,

or services directly to the business.

Next, the indirect investment called retained earnings.

Retained earnings is increased by the net income

and decreased by dividends paid out

to the owners, as well as losses from the income statement.

Retained earnings is the profit that is kept in the business

to help them grow in the future.

It is considered indirect because the business decides

what they will keep and what will be paid out to the owners.

So, to summarize, equity is made up of the direct investment

by the owners, as well as a net income retained

in the business for future expansion and growth.

Let's do a quick check your understanding.

Remember to pause the video and answer before I answer for you.

The right to receive money in the future from a customer

is an?

Asset called accounts receivable.

It's an asset because it has future benefit

for the business that will be converted into cash.

The right to collect cash in the future

is a legal right which is owned, and it is recorded

due to a past transaction.

Now that we understand the elements that make up

the balance sheet, we can look at an example of a balance

sheet.

Note that the statement is so large

that I've divided it into sections so

that you can see them better.

However, the balance sheet written out on paper

would show all these sections together,

one right after the other.

As always, the statement starts with the heading,

which must include the business name and the title

of the financial statement.

One change from previous statements, the balance sheet

is at a point in time, not for a period of time.

Why?

Because every time a business has another transaction

their financial position changes.

For example, if you have $10 in your pocket

and then you buy a [INAUDIBLE] your financial position

has changed.

That's why the balance sheet is a snapshot, one second of time.

The title of the statement reflects that.

Listed first on the balance sheet

are the assets with the heading assets.

Then there is a subheading called current assets.

There you'll see the details of the current asset section.

Notice that the assets are listed in order of liquidity.

The faster that business can convert the assets into cash,

sell, or use them, the higher they are on the list.

For example, accounts receivable is listed before inventory,

because the business is likely to collect

the cash from their customers before they

sell more inventory.

Note that assets which will be converted into cash

are always listed before assets which will be used or consumed.

Inventory can be sold for cash but prepaid insurance

will be used up over time.

So both the prepaid insurance and supplies are listed last.

Is the order of the items that will be used up over time

important?

Actually no.

I could have listed supplies before prepaid insurance,

and the statement would still be correct.