3-1 Notes
CHAPTER 3
BALANCE SHEET: PRESENTING AND ANALYZING RESOURCES AND
FINANCING
I. Learning Objectives
1. Understand the accounting concepts of assets, liabilities, and shareholders’
equity; including the criteria for recognizing (recording) these items on the
balance sheet, determining their amount (measurement), and identifying
where these items appear on the balance sheet (classification).
2. Understand why and how the recognition and measurement guidance in
U.S. GAAP and IFRS affects the information reported on balance sheets,
and develop skills for adjusting the reported amounts.
3. Develop skills to analyze the relations among assets, liabilities, and
shareholders’ equity.
II. Organization of Class Sessions
We recommend coverage of the material in this chapter in four steps. First,
Learning Objectives discuss the concepts of assets, liabilities, and shareholders’
equity, along with the rationale for using acquisition cost. The material tends to
be “theoretical” from the students’ viewpoint, use exercises applying these
concepts in specific situations at the end of the chapter. Second, discuss why and
how the recognition and measurement guidance in U.S. GAAP and IFRS affects
the information reported on balance sheets. Use exercises applying these concepts
in specific situations at the end of the chapter. Next, explain Liability recognition
and measurement and Shareholders’ Equity measurement and its disclosure.
Fourth, examine the balance sheets of firms in several different industries or use
problems at the end of the chapter to introduce students to the analysis and
interpretation of balance sheets.
III. Lecture Outline
1. Understand the accounting concepts of assets, liabilities, and
shareholders’ equity, including the criteria for recognizing (recording)
these items on the balance sheet, determining their amount
(measurement), and identifying where these items appear on the
balance sheet (classification).
Notes 3-2
Chapter 1 described the various financial statements. One among them
includes the Balance Sheet, which is also called as the statement of financial
position. Consider the Exhibit 1.1 provided in Chapter 1 which provides a
consolidated Balance Sheet. Explain the students on the major classification
in the balance sheet comprising of assets (resources), liability and
shareholders’ equity (financing of these resources).
A. Assets (Exercises 3.18, 3.19, 3.20, 3.22, 3.23).
Continue, further on how the assets are classified in the Balance Sheet
recognition which includes:
i. The firm owns or controls the right to use the item.
ii. The right to use the item arises as a result of a past
transaction or exchange.
iii. The future benefit has a relevant measurement attribute that
can be quantified with sufficient reliability.
an obligation to make a future sacrifice because of a past event or
transaction, for which it has little or no discretion to avoid. The liabilities
provided in Exhibit 1.1 could be explained to the students. Also, further
classification of liabilities as current liabilities and noncurrent liabilities
could be explained; Obligations that management expects to discharge
with a cash payment or otherwise settle during the operating cycle are
current liabilities, whereas all other obligations are noncurrent liabilities.
3-3 Notes
well as measurement. Further Figure 3.1 could be used, which classifies
the obligations into six categories based on their characteristics.
jurisdictions require that, within shareholders’ equity, firms distinguish
between amounts received from owners and amounts generated by
operations which the firm has not distributed to owners.
Proceeding one step ahead, conclude that many firms further
disaggregate the initial amounts they received from shareholders for
2. Understand why and how the recognition and measurement guidance
in U.S. GAAP and IFRS affects the information reported on balance
sheets, and develop skills for adjusting the reported amounts.
This is the students’ first introduction to U.S.GAAP and IFRS. We work
through the logic of this framework slowly and systematically.
A. The criteria that an item must meet to be an asset or a liability on a
balance sheet as discussed in the previous objective. Do these conditions
differ between U.S. GAAP and IFRS?
B. Next, identify the number appears next to the item on the balance sheet?
Do measurements differ between U.S. GAAP and IFRS?
C. Next, identify how do shareholder’ equity appear on the balance sheet?
Are their measurement and their disclosure the same under U.S. GAAP
and IFRS?
D. Then understand the guidance provided by U.S. GAAP and IFRS for fair
value measurements, acquisition cost, current replacement cost and net
realizable value.
Notes 3-4
E. Next, Understanding of the asset management basis for financial
reporting.
F. Last, Understand the difference in asset and liability definitions and
recognition criteria under U.S. GAAP and IFRS.
G. Three of our favorite problems (Problems 3.29, 3.30 and 3.31) require
students to prepare balance sheets using U.S. GAAP and IFRS. The
instructor should not assign or discuss these problems in class until
covering thoroughly the preceding steps.
3. Develop skills to analyze the relations among assets, liabilities, and
shareholders’ equity.
We attempt to get our students to think early in the course about using
financial statements. To this end, we have them look at balance sheets of
firms in a few industries to begin observing differences in the structure of
assets, liabilities and shareholders’ equity. Problem 3.32 involves a
restaurant chain and Problem 3.33 involves a construction firm. Other
possibilities are capital-intensive firms with large proportions of debt
(airlines), capital-intensive firms with little debt (pharmaceutical companies),
and labor-intensive firms (advertising agencies). Problems 3.34 and 3.35
present balance sheets and ask why the market value of shareholders’ equity
differs from the book value. These problems get students to think about asset
and liability recognition and valuation issues. Problem 3.36 asks students to
identify the likely industry of a firm from looking at its balance sheet. In a
similar vein, you may wish to refer students at this point to Problem 6.32 to
illustrate balance sheet relations for firms in different industries. We do not
assign Problem 6.32 at this point in the course.