WEBVTT

NOTE Understanding the balance sheet

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A bicycle maker reports 1,200,000 dollars of total assets.

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Can it pay a supplier next week?

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The balance sheet starts that answer, but it cannot finish it alone.

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Session 10 classifies what a company reports,

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tests what the reported amounts can show, and compares amounts across years.

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A balance sheet reports a company's financial position at one date.

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Assets are the resources the company reports.

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Liabilities are the obligations it reports.

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Equity is the owners' residual interest, the amount of assets left after

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liabilities.

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Reported assets minus reported liabilities equals reported equity.

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Two questions guide today's class.

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What do the reported amounts represent?

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And how are they classified?

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Assets fall into a few major types.

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Cash is available funds, subject to any restrictions.

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Receivables are amounts that customers or others owe the company.

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Inventory is goods held for sale, and prepayments are benefits paid for in

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advance.

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Investments are financial interests the company holds.

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Property and equipment are resources used repeatedly in operations.

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Intangible and other assets include nonphysical rights.

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Later topics decide when each one is recognized and how it is measured.

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Liabilities are obligations the company still has to settle.

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Payables and accruals are amounts owed to suppliers,

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employees, governments, and others.

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A customer advance is cash received before the company provides the promised

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goods or services.

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Borrowings are principal the company must repay to lenders.

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A warranty obligation is future performance that arises from past sales.

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The account names the obligation.

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Classification tells you when the company expects to settle it.

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Why classify at all?

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Suppose a company holds 100,000 dollars of cash for operations and 100,000

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dollars of equipment it will use for 5 years.

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Both are assets of the same amount, but they play different roles.

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Current items are resources expected to be available,

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sold, collected, or consumed, and obligations expected to be settled, within

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the current-classification period.

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Noncurrent items belong to later periods.

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Classification changes where an amount appears.

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It does not change the total reported.

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We start by classifying assets.

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For each one, ask what the company expects to do with it.

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Expected use decides an asset's classification.

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Some assets move through the operating cycle.

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The company sells,

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collects, or consumes them, so timing matters.

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Other assets serve the company over multiple periods, and those are generally

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noncurrent.

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A third group carries a restriction.

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For a restricted asset, the purpose of the restriction can change the

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classification.

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Two classroom companies carry today's examples.

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Riverton Bicycles manufactures and sells bicycles.

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Northfield Systems Support provides recurring building-systems support

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services.

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Riverton sells bicycle components and completed bicycles.

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Both companies collect receivables from customers.

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Northfield consumes diagnostic supplies while it provides service, and both

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companies consume prepaid services such as insurance.

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The operating cycle is a company's ordinary process, through collection from

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the customer.

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Riverton acquires components,

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assembles bicycles, and sells them.

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If it sells on credit, it records a receivable, and the cycle ends when it

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collects the cash.

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Northfield uses technician labor and diagnostic supplies to provide support.

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If it bills later, it records a receivable, and then it collects the cash.

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What counts as current?

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Use 12 months or the normal operating cycle, whichever is longer.

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When the cycle is shorter than 12 months, use 12 months.

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When the cycle is longer than 12 months, use the cycle.

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Current classification needs a time horizon.

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With a 20-month operating cycle, inventory that completes sale and collection

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in 17 months is still current.

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Some assets never pass through the sale-and-collection process.

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Manufacturing equipment, delivery vehicles, office buildings, and land used in

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operations all support the cycle.

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For these, do not ask where the asset sits in the operating cycle.

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Ask whether the company keeps it for continuing use.

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Assets retained for continuing use are generally noncurrent.

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Riverton manufactures bicycles from purchased components.

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It holds some tangible resources for sale and uses others repeatedly.

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Components and completed bicycles are inventory.

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Riverton holds them for sale, and they move through its operating process.

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Assembly equipment and delivery vehicles are property and equipment.

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Riverton uses them repeatedly and does not hold them for sale.

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Cash is normally current when it is available for current operations.

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First ask whether the cash is restricted.

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If it is not, apply the normal current-asset rules.

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If it is, ask what the restriction is for.

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Cash restricted to settle a current obligation may still be current.

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Riverton reserves cash for a 2028 assembly-line replacement, so that cash is

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generally noncurrent.

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The expected spending date alone does not decide the classification.

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Here is the first iClicker question.

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Which item is most likely a current asset at December 31, 2026?

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A, Riverton's bicycle assembly equipment, used for several years.

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B, Northfield's diagnostic supplies, expected to be consumed during the next 3

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months.

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C, Riverton's cash restricted for a 2028 assembly-line replacement.

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D, Northfield's service vehicles, used repeatedly in operations.

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Pause the video and choose one.

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The answer is B.

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Northfield will consume the supplies within 3 months, so they are current.

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Riverton uses the assembly equipment over multiple periods, so it is

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noncurrent.

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The cash restricted for 2028 serves a noncurrent purpose.

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Northfield uses its service vehicles repeatedly, so they are noncurrent too.

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Now you classify.

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Northfield's normal operating cycle is 1 month.

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Its list has 8 asset amounts.

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Cash is 45,000 dollars for operations and 20,000 dollars restricted for

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vehicles.

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Trade receivables are 73,000 dollars, with a 3,000 dollar allowance for credit

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losses.

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Diagnostic supplies are 20,000 dollars, and prepaid insurance is 15,000

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dollars.

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Equipment and vehicles are 290,000 dollars, with 60,000 dollars of accumulated

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depreciation.

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Classify each amount as current or noncurrent.

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Keep each contra account with the asset it reduces.

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Pause the video for 5 minutes.

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Northfield's 1-month cycle is shorter than 12 months, so it uses a 12-month

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period.

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Operating cash of 45,000 dollars is current.

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Trade receivables of 73,000 dollars are current, because Northfield expects to

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collect them within 30 days, and the allowance of 3,000 dollars goes with

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them.

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Prepaid insurance of 15,000 dollars runs through June 30, 2027, so it is

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current.

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Diagnostic supplies of 20,000 dollars are current.

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The restricted vehicle cash of 20,000 dollars is noncurrent, because it is

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held for purchases in 2028.

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Equipment and vehicles of 290,000 dollars are noncurrent, and the accumulated

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depreciation of 60,000 dollars goes with them.

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Next, we classify liabilities.

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For each one, ask what the company still owes and when it expects to settle

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it.

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Classify a liability in 3 steps.

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Start with what the company still owes:

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cash, goods or services, or other performance.

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Then determine the expected settlement period.

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Use 12 months or the normal operating cycle, whichever is longer.

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Last, classify the obligation.

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Settlement expected within that period is current, and settlement expected

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after it is noncurrent.

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Certain borrowing arrangements need more analysis, and we cover them next

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class.

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Settlement does not always mean paying cash.

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Riverton settles accounts payable with cash to a supplier, and wages payable

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with cash to employees.

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It settles a customer advance by delivering bicycles.

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Northfield settles its customer advance by providing support services.

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Riverton settles its warranty liability by repairing or replacing a bicycle.

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The form of settlement does not, by itself, decide whether a liability is

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current.

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Cash received before performance is a liability.

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It is not revenue.

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Riverton collected 50,000 dollars for bicycles it has not yet delivered.

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It debits Cash for 50,000 dollars and credits Customer Advances for 50,000

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dollars.

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Riverton expects to deliver by March 31, 2027, within the 12-month period, so

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the advance is current.

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The Accounting Standards Codification, or A S C, sets the revenue rules in

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Topic 606.

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If the contract criteria are met, the payment is a contract liability under A

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S C 606-10-45-2.

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Before those criteria are met, A S C 606-10-25-8 still requires a liability.

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Receiving cash does not create revenue.

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At December 31, 2026, Riverton owes 460,000 dollars of loan principal.

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Ignore interest.

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Four payments of 25,000 dollars are due during 2027, on March 31, June 30,

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September 30, and December 31.

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Those 4 payments total 100,000 dollars, and that portion is current.

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The remaining 360,000 dollars is due after 2027, so it is noncurrent.

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One loan appears in both groups.

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Now classify Northfield's obligations.

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Its operating cycle is 1 month.

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Customer advances of 15,000 dollars cover services during the next 2 months.

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Accounts payable of 20,000 dollars are due within 30 days.

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Vacation payable of 6,000 dollars will be settled during 2027.

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Utilities payable of 4,000 dollars, wages payable of 15,000 dollars, and

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payroll liabilities of 2,000 dollars are due in January 2027.

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Loan principal is 138,000 dollars.

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Of that, 8,000 dollars is due during 2027, 8,000 dollars during 2028, and

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122,000 dollars after 2028.

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Pause the video and decide which amounts are current.

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Every obligation except part of the loan is current.

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The customer advances,

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accounts payable, vacation payable,

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utilities payable, wages payable, and payroll liabilities will all be settled

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within 12 months.

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The loan splits into 3 parts.

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The 8,000 dollars due during 2027 is current.

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The 8,000 dollars due during 2028 and the 122,000 dollars due after 2028 are

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noncurrent, because they fall after the 12-month period.

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Here is the second iClicker question.

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Northfield receives cash in December for support services it will provide

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during the next 2 months.

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At December 31, how should the unearned amount be classified?

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A, revenue, because cash has already been collected.

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B, a current liability, because Northfield still owes near-term service.

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C, a noncurrent liability, because settlement will not require cash.

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D, equity, because the customer has already financed the company.

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Pause the video and choose one.

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The answer is B.

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Northfield still owes service during the next 2 months, so the advance is a

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current liability.

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Collecting cash does not create revenue while the service is still owed.

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A liability settled through service can still be current.

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And customer financing does not create shareholders' equity.

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Now we turn to equity and put the classified balance sheet together.

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Residual interest means the reported assets that remain after reported

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liabilities are deducted.

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Riverton reports assets of 1,200,000 dollars and liabilities of 760,000

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dollars, so its reported equity is 440,000 dollars.

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Equity is not a separate resource the company can spend.

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Equity accounts describe interests in net assets.

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They do not tell you where the company's resources are held.

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Keep two questions apart.

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Measurement asks what amount is reported.

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Accounting measurement rules set the dollar amount for an asset or liability.

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Classification asks where that amount is presented, in the current group or

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the noncurrent group.

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Changing an item's classification changes its presentation.

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It does not change the measured amount.

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Now build Riverton's classified balance sheet at December 31, 2026.

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Riverton's normal operating cycle is 4 months.

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The slide lists 18 adjusted accounts with the facts you need.

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Present each valuation account with its asset, and calculate the subtotals.

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Pause the video for 5 to 7 minutes.

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Start with assets.

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Operating cash is 120,000 dollars.

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Trade receivables are 157,000 dollars less an allowance of 7,000 dollars, or

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150,000 dollars net.

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Inventory of 320,000 dollars moves through the 4-month cycle.

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Prepaid insurance of 30,000 dollars runs through September 30, 2027.

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Total current assets are 620,000 dollars.

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Restricted construction cash of 80,000 dollars is noncurrent.

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Property and equipment cost 660,000 dollars, less 160,000 dollars of

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accumulated depreciation, or 500,000 dollars net.

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Total noncurrent assets are 580,000 dollars, and total assets are 1,200,000

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dollars.

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Now liabilities and equity.

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Seven obligations are current.

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Accounts payable are 190,000 dollars, wages payable 30,000 dollars, and

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00:15:39.060 --> 00:15:42.180
payroll liabilities 8,000 dollars.

250
00:15:42.180 --> 00:15:47.260
Customer advances are 50,000 dollars, the warranty liability 12,000 dollars,

251
00:15:47.260 --> 00:15:51.000
and utilities payable 10,000 dollars.

252
00:15:51.000 --> 00:15:54.920
Loan principal of 100,000 dollars is due during 2027.

253
00:15:55.800 --> 00:16:00.060
Total current liabilities are 400,000 dollars.

254
00:16:00.060 --> 00:16:06.260
Loan principal of 360,000 dollars due after 2027 is noncurrent, so total

255
00:16:06.260 --> 00:16:09.920
liabilities are 760,000 dollars.

256
00:16:09.920 --> 00:16:15.340
Common stock of 200,000 dollars and retained earnings of 240,000 dollars make

257
00:16:15.340 --> 00:16:19.360
shareholders' equity of 440,000 dollars.

258
00:16:19.360 --> 00:16:23.437
Liabilities and equity total 1,200,000 dollars.

259
00:16:24.337 --> 00:16:25.837
Here is the finished statement.

260
00:16:26.877 --> 00:16:32.797
Current assets of 620,000 dollars and noncurrent assets of 580,000 dollars

261
00:16:32.797 --> 00:16:37.937
make total assets of 1,200,000 dollars.

262
00:16:37.937 --> 00:16:43.497
Current liabilities of 400,000 dollars and long-term loan principal of 360,000

263
00:16:43.497 --> 00:16:49.237
dollars make total liabilities of 760,000 dollars.

264
00:16:49.237 --> 00:16:56.134
Equity of 440,000 dollars brings liabilities and equity to 1,200,000 dollars.

265
00:16:57.034 --> 00:17:01.534
Next, we ask what the reported amounts can tell you, and what they cannot.

266
00:17:02.927 --> 00:17:07.107
Before you interpret a balance-sheet amount, separate 3 questions.

267
00:17:08.367 --> 00:17:11.927
Recognition asks whether the item should appear in the financial statements at

268
00:17:11.927 --> 00:17:12.427
all.

269
00:17:13.187 --> 00:17:15.807
Measurement asks what dollar amount should be reported.

270
00:17:17.027 --> 00:17:21.367
Interpretation asks what the reported amount tells you and what it does not.

271
00:17:22.067 --> 00:17:24.447
The A S C follows the same structure.

272
00:17:25.367 --> 00:17:27.947
Section 25 of a subtopic covers recognition.

273
00:17:28.927 --> 00:17:33.427
Section 30 covers initial measurement, and Section 35 covers subsequent

274
00:17:33.427 --> 00:17:33.727
measurement.

275
00:17:35.258 --> 00:17:40.178
Economic usefulness alone does not create a separately recognized asset.

276
00:17:41.158 --> 00:17:45.018
Recognition depends on the applicable accounting requirements and on how the

277
00:17:45.018 --> 00:17:47.378
company obtained or developed the resource.

278
00:17:47.778 --> 00:17:53.678
An internally developed brand may support future sales without appearing as a

279
00:17:53.678 --> 00:17:54.038
separate asset.

280
00:17:55.342 --> 00:17:59.782
A carrying amount is the amount reported after the relevant measurement

281
00:17:59.782 --> 00:18:01.282
requirements and adjustments.

282
00:18:02.422 --> 00:18:08.862
Riverton reports property and equipment at historical cost of 660,000 dollars,

283
00:18:08.862 --> 00:18:15.182
less 160,000 dollars of accumulated depreciation, or 500,000 dollars.

284
00:18:15.182 --> 00:18:22.112
It reports trade receivables of 157,000 dollars less an allowance of 7,000

285
00:18:22.112 --> 00:18:27.582
dollars for expected credit losses, or 150,000 dollars.

286
00:18:27.582 --> 00:18:31.362
Total assets adds amounts that come from these different measurement

287
00:18:31.362 --> 00:18:31.802
processes.

288
00:18:33.192 --> 00:18:35.012
Here is a claim to evaluate.

289
00:18:35.772 --> 00:18:41.592
Riverton reports 440,000 dollars of equity, so the shareholders' interest must

290
00:18:41.592 --> 00:18:44.402
be worth 440,000 dollars.

291
00:18:44.402 --> 00:18:47.512
Why doesn't that conclusion follow from the balance sheet alone?

292
00:18:48.372 --> 00:18:52.292
Some valuable resources may not be separately recognized.

293
00:18:53.352 --> 00:18:56.392
Carrying amounts are not necessarily current market values.

294
00:18:56.902 --> 00:19:01.802
And a buyer also considers expected future performance and risk.

295
00:19:02.845 --> 00:19:06.165
The face of the balance sheet summarizes reported amounts.

296
00:19:06.785 --> 00:19:09.905
The notes give the detail you need to understand many of them.

297
00:19:10.465 --> 00:19:14.925
The balance sheet may show property and equipment, net, and the notes say what

298
00:19:14.925 --> 00:19:15.865
the line contains.

299
00:19:16.585 --> 00:19:19.765
For other assets, the notes give important measurement policies.

300
00:19:20.485 --> 00:19:23.545
For long-term debt, the notes give maturities and terms.

301
00:19:24.285 --> 00:19:27.985
For restricted cash, the notes describe the restrictions and other relevant

302
00:19:27.985 --> 00:19:28.405
facts.

303
00:19:29.675 --> 00:19:31.735
Here is the third iClicker question.

304
00:19:32.635 --> 00:19:39.215
A company reports equipment at 420,000 dollars of cost less 150,000 dollars of

305
00:19:39.215 --> 00:19:40.515
accumulated depreciation.

306
00:19:41.315 --> 00:19:45.675
Its valuable internally developed customer list is not separately recognized.

307
00:19:46.455 --> 00:19:48.295
Which conclusion is best supported?

308
00:19:49.175 --> 00:19:53.535
A, total assets equal the current market value of all controlled resources.

309
00:19:54.295 --> 00:19:58.755
B, the 270,000 dollars is what the company would receive for the equipment.

310
00:19:59.515 --> 00:20:04.335
C, the balance sheet can omit valuable resources and use amounts other than

311
00:20:04.335 --> 00:20:05.395
current market value.

312
00:20:06.135 --> 00:20:09.695
D, management should record the customer list at its estimated value.

313
00:20:10.735 --> 00:20:11.955
Pause the video and choose one.

314
00:20:13.223 --> 00:20:14.503
The answer is C.

315
00:20:14.983 --> 00:20:19.383
The customer list is not recognized, and the equipment is reported at cost

316
00:20:19.383 --> 00:20:21.583
less accumulated depreciation.

317
00:20:22.403 --> 00:20:26.603
Choice A is wrong, because accounting rules can exclude resources and use

318
00:20:26.603 --> 00:20:27.263
other measures.

319
00:20:28.423 --> 00:20:32.983
Choice B is wrong, because cost less accumulated depreciation does not

320
00:20:32.983 --> 00:20:34.243
estimate sale proceeds.

321
00:20:35.423 --> 00:20:40.983
Choice D is wrong, because economic value alone does not permit recognizing an

322
00:20:40.983 --> 00:20:41.903
internally developed list.

323
00:20:43.129 --> 00:20:45.249
The next question is liquidity.

324
00:20:45.909 --> 00:20:47.929
Can Riverton pay what it owes soon?

325
00:20:49.230 --> 00:20:54.070
Liquidity is a company's ability to meet near-term obligations as they come

326
00:20:54.070 --> 00:20:56.990
due, using resources available now or soon.

327
00:20:57.850 --> 00:21:00.990
Solvency concerns obligations over longer horizons.

328
00:21:02.050 --> 00:21:06.770
Current assets are resources expected to be sold, collected, consumed, or

329
00:21:06.770 --> 00:21:09.970
otherwise available within the current-classification period.

330
00:21:10.750 --> 00:21:14.810
Current liabilities are obligations expected to be settled within that period.

331
00:21:15.730 --> 00:21:17.810
Comparing the two groups gives a starting view.

332
00:21:17.810 --> 00:21:23.010
It does not show whether particular resources become cash before particular

333
00:21:23.010 --> 00:21:24.150
obligations come due.

334
00:21:25.345 --> 00:21:27.165
Two measures compare those groups.

335
00:21:28.265 --> 00:21:31.705
Working capital is current assets minus current liabilities.

336
00:21:32.265 --> 00:21:37.805
The dollar difference shows how far current resources exceed or fall short of

337
00:21:37.805 --> 00:21:38.585
current obligations.

338
00:21:39.225 --> 00:21:43.665
The current ratio is current assets divided by current liabilities.

339
00:21:44.245 --> 00:21:48.985
It gives current resources for each 1 dollar of current liabilities, so it

340
00:21:48.985 --> 00:21:50.985
helps you compare companies of different sizes.

341
00:21:51.825 --> 00:21:56.585
Neither measure shows the timing of each asset or liability, or how readily

342
00:21:56.585 --> 00:21:58.045
each asset becomes cash.

343
00:21:58.825 --> 00:21:59.785
Both are starting points.

344
00:22:01.027 --> 00:22:05.587
Now calculate Riverton's working capital and current ratio from its balance

345
00:22:05.587 --> 00:22:08.347
sheet at December 31, 2026.

346
00:22:09.247 --> 00:22:11.287
Work on your own or with the people around you.

347
00:22:11.927 --> 00:22:13.417
Pause the video for a couple of minutes.

348
00:22:14.532 --> 00:22:20.732
Current assets are 620,000 dollars, and current liabilities are 400,000

349
00:22:20.732 --> 00:22:21.772
dollars.

350
00:22:21.772 --> 00:22:29.692
Working capital is 620,000 dollars minus 400,000 dollars, or 220,000 dollars.

351
00:22:29.692 --> 00:22:37.952
The current ratio is 620,000 dollars divided by 400,000 dollars, or 1.55.

352
00:22:37.952 --> 00:22:42.732
Leave out the noncurrent balances: restricted cash of 80,000 dollars, net

353
00:22:42.732 --> 00:22:48.932
equipment of 500,000 dollars, and loan principal of 360,000 dollars.

354
00:22:48.932 --> 00:22:52.412
Equity of 440,000 dollars is not part of either measure.

355
00:22:53.630 --> 00:22:59.050
Riverton's 620,000 dollars of current assets includes operating cash of

356
00:22:59.050 --> 00:23:06.280
120,000 dollars, net receivables of 150,000 dollars, inventory of 320,000

357
00:23:06.280 --> 00:23:11.070
dollars, and prepaid insurance of 30,000 dollars.

358
00:23:11.070 --> 00:23:15.690
Inventory must be sold, and for a credit sale collected, before it becomes

359
00:23:15.690 --> 00:23:16.110
cash.

360
00:23:17.030 --> 00:23:19.250
More inventory can raise the current ratio.

361
00:23:19.890 --> 00:23:26.850
A ratio of 1.55 does not mean Riverton holds 1.55 dollars of cash for each

362
00:23:26.850 --> 00:23:27.640
dollar it owes.

363
00:23:28.732 --> 00:23:31.712
Start from Riverton's December 31 balances.

364
00:23:32.752 --> 00:23:36.852
Riverton buys 60,000 dollars of materials for cash, and no other balance

365
00:23:36.852 --> 00:23:37.312
changes.

366
00:23:38.272 --> 00:23:39.452
Fill in operating cash,

367
00:23:40.352 --> 00:23:44.472
inventory, total current assets, total current liabilities, and the current

368
00:23:44.472 --> 00:23:45.992
ratio after the purchase.

369
00:23:46.672 --> 00:23:50.342
Then ask whether Riverton's immediate access to cash has changed.

370
00:23:51.092 --> 00:23:52.352
Pause the video and work it out.

371
00:23:53.586 --> 00:23:59.506
Operating cash falls from 120,000 dollars to 60,000 dollars.

372
00:23:59.506 --> 00:24:05.206
Inventory rises from 320,000 dollars to 380,000 dollars.

373
00:24:05.206 --> 00:24:10.266
Total current assets stay at 620,000 dollars, and current liabilities stay at

374
00:24:10.266 --> 00:24:12.026
400,000 dollars.

375
00:24:12.026 --> 00:24:15.986
The current ratio stays at 1.55.

376
00:24:15.986 --> 00:24:20.046
Riverton now has 60,000 dollars less cash available for immediate use.

377
00:24:21.254 --> 00:24:23.874
Start again from the December 31 balances.

378
00:24:24.774 --> 00:24:29.794
Now Riverton pays 60,000 dollars of accounts payable with operating cash, and

379
00:24:29.794 --> 00:24:31.054
no other balance changes.

380
00:24:32.214 --> 00:24:35.614
Calculate operating cash, accounts payable, both totals,

381
00:24:36.574 --> 00:24:39.544
working capital, and the current ratio after the payment.

382
00:24:39.794 --> 00:24:42.374
Then decide what you can conclude about liquidity.

383
00:24:43.334 --> 00:24:44.614
Pause the video and work it out.

384
00:24:45.838 --> 00:24:49.478
Operating cash falls to 60,000 dollars.

385
00:24:49.478 --> 00:24:54.377
Current assets fall to 560,000 dollars, and current liabilities fall to

386
00:24:54.377 --> 00:24:56.598
340,000 dollars.

387
00:24:56.598 --> 00:25:01.948
Both totals fell by 60,000 dollars, so working capital stays at 220,000

388
00:25:01.948 --> 00:25:02.997
dollars.

389
00:25:02.997 --> 00:25:10.797
The current ratio rises from 1.55 to 1.65, because 560,000 dollars divided by

390
00:25:10.797 --> 00:25:14.518
340,000 dollars is 1.65.

391
00:25:14.518 --> 00:25:18.937
Current liabilities started lower, so the same payment removed a larger share

392
00:25:18.937 --> 00:25:19.348
of them.

393
00:25:19.937 --> 00:25:23.018
Riverton now has less cash and fewer unpaid obligations.

394
00:25:23.757 --> 00:25:27.538
The higher ratio alone does not show that its ability to make the next payment

395
00:25:27.538 --> 00:25:28.218
improved.

396
00:25:29.516 --> 00:25:31.716
Here is the fourth iClicker question.

397
00:25:32.376 --> 00:25:37.056
A company begins with current assets of 300,000 dollars and current

398
00:25:37.056 --> 00:25:39.596
liabilities of 200,000 dollars.

399
00:25:39.596 --> 00:25:43.276
It pays 40,000 dollars of wages payable with cash.

400
00:25:43.936 --> 00:25:45.406
Which result is correct?

401
00:25:46.036 --> 00:25:52.716
A, working capital falls to 60,000 dollars, and the current ratio stays 1.50.

402
00:25:52.716 --> 00:26:00.096
B, working capital stays 100,000 dollars, and the current ratio rises to 1.63.

403
00:26:00.096 --> 00:26:06.796
C, working capital stays 100,000 dollars, and the current ratio falls to 1.30.

404
00:26:06.796 --> 00:26:12.336
D, working capital rises to 140,000 dollars, and the current ratio rises to

405
00:26:12.336 --> 00:26:14.336
1.63.

406
00:26:14.336 --> 00:26:15.676
Pause the video and choose one.

407
00:26:16.908 --> 00:26:18.148
The answer is B.

408
00:26:18.808 --> 00:26:23.748
After the payment, current assets are 260,000 dollars and current liabilities

409
00:26:23.748 --> 00:26:26.628
are 160,000 dollars.

410
00:26:26.628 --> 00:26:33.508
Working capital is 260,000 dollars minus 160,000 dollars, or 100,000 dollars,

411
00:26:33.508 --> 00:26:34.408
the same as before.

412
00:26:35.148 --> 00:26:42.688
The current ratio is 260,000 dollars divided by 160,000 dollars, or 1.625,

413
00:26:42.688 --> 00:26:45.148
which rounds to 1.63.

414
00:26:45.148 --> 00:26:49.388
Equal reductions leave working capital unchanged, so A and D are wrong.

415
00:26:50.148 --> 00:26:54.688
The ratio rises, because 40,000 dollars is a larger share of the smaller

416
00:26:54.688 --> 00:26:56.648
liability balance, so C is wrong.

417
00:26:58.021 --> 00:27:01.381
Next, we compare reported amounts across years.

418
00:27:02.860 --> 00:27:04.580
Before you compare periods,

419
00:27:05.440 --> 00:27:08.690
companies, or balances, check that the inputs are comparable.

420
00:27:09.540 --> 00:27:13.100
Ask whether the amounts include the same kinds of accounts or components.

421
00:27:14.160 --> 00:27:17.960
Ask whether components are combined, separated, or netted in the same way.

422
00:27:18.560 --> 00:27:22.520
And ask whether accounting policies and estimates are comparable enough for

423
00:27:22.520 --> 00:27:23.000
your question.

424
00:27:23.760 --> 00:27:26.890
Then choose the comparison that answers your question.

425
00:27:27.968 --> 00:27:32.608
An analyst is comparing Riverton's cash-related balances across years.

426
00:27:33.388 --> 00:27:38.708
Riverton's 2025 filing reported one caption, cash and restricted cash, of

427
00:27:38.708 --> 00:27:40.668
200,000 dollars.

428
00:27:40.668 --> 00:27:46.588
Its 2026 filing reports operating cash of 120,000 dollars and restricted

429
00:27:46.588 --> 00:27:49.428
construction cash of 80,000 dollars separately.

430
00:27:49.648 --> 00:27:54.668
The 2026 filing also presents 2025 amounts in the newer format.

431
00:27:55.068 --> 00:28:00.808
The analyst compares the old 200,000 dollars with 2026 operating cash of

432
00:28:00.808 --> 00:28:03.088
120,000 dollars.

433
00:28:03.088 --> 00:28:08.048
What should the analyst do before interpreting the apparent decrease of 80,000

434
00:28:08.048 --> 00:28:08.968
dollars?

435
00:28:08.968 --> 00:28:09.848
Pause and decide.

436
00:28:11.075 --> 00:28:14.235
The analyst should use amounts presented on the same basis.

437
00:28:14.895 --> 00:28:20.115
The best source is the comparative 2025 amounts in the 2026 filing, which use

438
00:28:20.115 --> 00:28:21.915
the current presentation for both years.

439
00:28:22.735 --> 00:28:27.975
Do not compare a combined 2025 caption with one component of the 2026

440
00:28:27.975 --> 00:28:28.475
presentation.

441
00:28:29.555 --> 00:28:33.815
Compare operating cash with operating cash, or rebuild total cash-related

442
00:28:33.815 --> 00:28:35.095
balances for both years.

443
00:28:35.375 --> 00:28:38.315
If the breakdown is not available, state that limit.

444
00:28:38.315 --> 00:28:41.095
Do not treat unlike amounts as equal.

445
00:28:42.353 --> 00:28:46.773
Horizontal analysis compares the same reported amount across periods.

446
00:28:47.533 --> 00:28:51.813
It applies to accounts, subtotals, totals, or other amounts measured

447
00:28:51.813 --> 00:28:52.433
consistently.

448
00:28:53.113 --> 00:28:57.153
The dollar change is the later amount minus the earlier amount.

449
00:28:57.793 --> 00:29:01.833
The percentage change is the dollar change divided by the earlier amount.

450
00:29:02.553 --> 00:29:06.353
When the earlier amount is 0, the percentage change is undefined.

451
00:29:06.353 --> 00:29:08.973
Report and describe the dollar change instead.

452
00:29:10.280 --> 00:29:15.800
Compare Riverton's inventory and total assets across 2025 and 2026.

453
00:29:16.560 --> 00:29:23.180
Inventory rose from 260,000 dollars to 320,000 dollars, a change of 60,000

454
00:29:23.180 --> 00:29:24.160
dollars.

455
00:29:24.160 --> 00:29:29.640
Divide by 260,000 dollars, and the increase is 23.08 percent.

456
00:29:29.640 --> 00:29:36.360
Total assets rose from 1,100,000 dollars to 1,200,000 dollars, a change of

457
00:29:36.360 --> 00:29:40.260
100,000 dollars, or 9.09 percent.

458
00:29:40.260 --> 00:29:45.320
Inventory grew more than twice as fast as total assets, so inventory is an

459
00:29:45.320 --> 00:29:45.960
amount to investigate.

460
00:29:47.324 --> 00:29:52.244
Common-size analysis states each reported amount as a percentage of a common

461
00:29:52.244 --> 00:29:52.624
base.

462
00:29:53.364 --> 00:29:58.064
The base lets you compare composition across periods or across companies of

463
00:29:58.064 --> 00:29:58.764
different sizes.

464
00:29:59.384 --> 00:30:03.664
On the balance sheet, the base is usually total assets at the same date.

465
00:30:04.204 --> 00:30:06.804
On the income statement, the base is usually revenue.

466
00:30:07.444 --> 00:30:12.664
A balance-sheet common-size percentage is the amount divided by total assets.

467
00:30:13.144 --> 00:30:17.864
A change between two common-size percentages is stated in percentage points.

468
00:30:19.162 --> 00:30:23.562
Has inventory become a larger or smaller part of Riverton's asset base?

469
00:30:24.382 --> 00:30:31.062
In 2025, inventory of 260,000 dollars divided by total assets of 1,100,000

470
00:30:31.062 --> 00:30:35.042
dollars is 23.64 percent.

471
00:30:35.042 --> 00:30:44.062
In 2026, 320,000 dollars divided by 1,200,000 dollars is 26.67 percent.

472
00:30:44.062 --> 00:30:47.582
The share rose by 3.03 percentage points.

473
00:30:48.222 --> 00:30:51.462
Inventory became a larger part of Riverton's reported resources.

474
00:30:52.743 --> 00:30:54.253
Put the signals in order.

475
00:30:55.403 --> 00:30:58.323
Inventory increased by 60,000 dollars.

476
00:30:58.323 --> 00:31:04.563
It grew 23.08 percent, while total assets grew 9.09 percent.

477
00:31:04.563 --> 00:31:12.493
Its share of total assets rose from 23.64 percent to 26.67 percent.

478
00:31:12.493 --> 00:31:18.643
The current ratio of 1.55 includes inventory, but it does not show whether the

479
00:31:18.643 --> 00:31:19.593
inventory is selling.

480
00:31:20.363 --> 00:31:24.223
Inventory turnover, in Unit 5, will help answer that.

481
00:31:25.183 --> 00:31:27.623
None of these calculations establishes the cause.

482
00:31:28.503 --> 00:31:32.203
Riverton may be preparing for higher sales, or it may be holding bicycles

483
00:31:32.203 --> 00:31:33.563
customers do not want.

484
00:31:34.063 --> 00:31:35.263
You need more facts.

485
00:31:36.545 --> 00:31:41.555
The last section connects balances at a date with activity over a period.

486
00:31:42.841 --> 00:31:46.961
A balance sheet reports resources and obligations at one date.

487
00:31:47.681 --> 00:31:51.031
An income statement reports activity over a period.

488
00:31:51.341 --> 00:31:55.861
A single ending balance may not represent the amount held throughout the

489
00:31:55.861 --> 00:31:56.011
period.

490
00:31:56.661 --> 00:32:00.861
When you relate a period's activity to the resources used during that period,

491
00:32:01.501 --> 00:32:04.121
consider whether an average balance is more representative.

492
00:32:05.554 --> 00:32:10.194
An average balance uses observations from the period to estimate a

493
00:32:10.194 --> 00:32:11.054
representative amount.

494
00:32:11.814 --> 00:32:16.444
It is the sum of the observed balances divided by the number of observations.

495
00:32:17.074 --> 00:32:21.514
With only annual statements, the beginning and ending balances are a common

496
00:32:21.514 --> 00:32:22.114
approximation.

497
00:32:23.054 --> 00:32:27.774
More frequent, regularly spaced observations may capture more of the variation

498
00:32:27.774 --> 00:32:28.514
during the year.

499
00:32:29.254 --> 00:32:33.634
The result is still an approximation, and it is not automatically a daily

500
00:32:33.634 --> 00:32:33.994
average.

501
00:32:33.994 --> 00:32:39.194
Use an average only when the question calls for a balance that represents a

502
00:32:39.194 --> 00:32:39.374
period.

503
00:32:40.891 --> 00:32:47.971
Riverton's inventory was 260,000 dollars at the end of 2025 and 320,000

504
00:32:47.971 --> 00:32:50.591
dollars at the end of 2026.

505
00:32:51.211 --> 00:32:57.291
The beginning-and-ending average is 260,000 dollars plus 320,000 dollars,

506
00:32:57.291 --> 00:33:01.061
divided by 2, or 290,000 dollars.

507
00:33:01.061 --> 00:33:08.981
The 2026 quarter-end balances were 300,000 dollars, 350,000 dollars, 370,000

508
00:33:08.981 --> 00:33:12.251
dollars, and 320,000 dollars.

509
00:33:12.251 --> 00:33:15.931
Their average is 335,000 dollars.

510
00:33:15.931 --> 00:33:19.871
The two sets of observations suggest different representative balances.

511
00:33:20.711 --> 00:33:24.591
Neither one establishes the inventory held on every day of the year.

512
00:33:25.833 --> 00:33:28.093
Choose the method that fits each question.

513
00:33:29.053 --> 00:33:32.193
First, did trade receivables increase compared with last year?

514
00:33:32.873 --> 00:33:36.933
Second, does property and equipment make up a larger share of total assets

515
00:33:36.933 --> 00:33:37.633
than last year?

516
00:33:38.573 --> 00:33:42.853
Third, what receivables balance best represents the resources outstanding

517
00:33:42.853 --> 00:33:45.103
while annual credit sales were generated?

518
00:33:45.993 --> 00:33:49.313
Fourth, what is the relationship between current assets and current

519
00:33:49.313 --> 00:33:50.913
liabilities at December 31?

520
00:33:51.513 --> 00:33:54.543
Pause the video and match each question to a method.

521
00:33:55.933 --> 00:34:00.853
The first question compares the same account across periods, so use horizontal

522
00:34:00.853 --> 00:34:01.353
analysis.

523
00:34:02.093 --> 00:34:06.093
The second asks about the account's share of the asset base, so use

524
00:34:06.093 --> 00:34:07.273
common-size analysis.

525
00:34:08.013 --> 00:34:12.753
The third relates a period's activity to a balance held during that period, so

526
00:34:12.753 --> 00:34:13.973
use an average balance.

527
00:34:14.473 --> 00:34:19.033
The fourth compares two amounts at one reporting date, so use the current

528
00:34:19.033 --> 00:34:20.113
ratio at that date.

529
00:34:21.336 --> 00:34:23.696
Here is the last iClicker question.

530
00:34:24.316 --> 00:34:29.856
A company's property and equipment increased from 240 million dollars to 300

531
00:34:29.856 --> 00:34:31.096
million dollars.

532
00:34:31.096 --> 00:34:36.936
Over the same period, total assets increased from 800 million dollars to 1.2

533
00:34:36.936 --> 00:34:38.316
billion dollars.

534
00:34:38.316 --> 00:34:42.916
Which analysis measures property and equipment as a share of total assets?

535
00:34:43.776 --> 00:34:47.676
A, horizontal percentage change in property and equipment only.

536
00:34:48.036 --> 00:34:49.836
B, working capital.

537
00:34:50.636 --> 00:34:55.036
C, common-size analysis using total assets as the base.

538
00:34:55.936 --> 00:34:58.316
D, average property and equipment balance.

539
00:34:59.256 --> 00:35:00.396
Pause the video and choose one.

540
00:35:01.688 --> 00:35:03.128
The answer is C.

541
00:35:03.128 --> 00:35:08.008
Common-size analysis states property and equipment as a percentage of total

542
00:35:08.008 --> 00:35:10.888
assets at each date, which answers the question directly.

543
00:35:12.188 --> 00:35:15.968
Horizontal analysis measures the change in that one account, not its share.

544
00:35:17.308 --> 00:35:20.348
Working capital compares current assets with current liabilities.

545
00:35:21.108 --> 00:35:25.408
An average measures a balance over a period, not its share of total assets.

546
00:35:26.742 --> 00:35:29.982
Next class is Tuesday, October 6.

547
00:35:29.982 --> 00:35:31.762
We account for current obligations.

548
00:35:32.582 --> 00:35:37.162
We record payables and accruals, and we classify debt using maturities,

549
00:35:37.682 --> 00:35:39.972
refinancing agreements, covenants, and waivers.

550
00:35:40.642 --> 00:35:43.942
We also determine the treatment of loss contingencies and warranties.

551
00:35:44.942 --> 00:35:46.322
Read Chapter 10 before class.