Lecture Managerial Accounting for the hospitality industry: Chapter 4 - Dopson, Hayes

Chapter 4 - The balance sheet. In this chapter you will learn why owners, investors, lenders, and managers all must know how to read and understand a balance sheet. You will also learn how accountants prepare a balance sheet and, most important, how managerial accountants evaluate the information contained in a balance sheet using vertical and horizontal analysis techniques.

Chapter 4

The Balance Sheet

Chapter Outline

Learning Outcomes

sheet for a hospitality business

prepare a balance sheet

financial condition of your own business

The Purpose of the Balance Sheet

balance sheet is of critical importance to several

different groups including:

accounting period, lets the owners of the business know about the amount of that business which they actually

“own”

satisfy a debt

the business before its owners can determine the

amount of their own equity (free and clear ownership)

(ROI) they receive

period is compared to its balance sheet covering

another time period, investors can measure their return

on investment

balance sheet if they are to accurately compute their

annual returns on investment (ROI)

to repay its debts

effort to better understand the financial strength (and

thus the repayment ability) of that business

about repayment

their customer’s respective balance sheets before a

decision was made regarding the wisdom of extending

credit to them

accurately indicates the long-term ability of a business

to repay a vendor who has extended credit to that

business

information found on the income statement than that

found on the balance sheet

their own balance sheets to determine items such as

the current financial balances of cash, accounts

receivable, inventories, and accounts payable, and

other accounts that have a direct impact on operations

Limitations of the Balance Sheet

that accountants utilize a variety of evaluation

approaches, each of which may make the most sense

for specific asset types based upon circumstances and available information

been criticized because of the company assets they do not value

balance sheet, none take into account the relative

value, or worth, of a restaurant or hotel’s staff, including its managers

Balance Sheet Formats

method of documenting the value of a business’s

assets, liabilities, and owner’s equity on a specific date

display the information on a balance sheet

balance sheet list the assets of a company on the left

side of the report and the liabilities and owner’s equity

accounts on the right side

Figure 4.1 Account Format Balance Sheet

Blue Lagoon Water Park Resort

Balance Sheet December 31, 2010 Assets Liabilities and Owners’ Equity

Net Receivables 1,053,950 Other Current Liabilities 1,264,600 Inventories 1,497,200 Total Current Liabilities 4,022,600 Total Current Assets 8,175,500

Long-Term Liabilities

Less Accumulated Depreciation 4,668,900 Paid in Capital 18,775,100 Net Property and Equipment 32,623,150 Retained Earnings 6,116,850

Total Assets 46,491,950 Total Liabilities and Owners’ Equity 46,491,950

Balance Sheet Formats

balance sheet list the assets of a company first and

then the liabilities and owner’s equity accounts

(vertically)

to the reader that assets equals liabilities plus owners

equity

sheet was prepared is clearly identified

Figure 4.2 Report Format Balance Sheet

Blue Lagoon Water Park Resort Balance Sheet December 31, 2010

Total Liabilities and Owners’ Equity 46,491,950

Balance Sheet Content

as possible about each of these three accounting

formula components

Why a Balance Sheet Balances –

Dr Dopson’s Stuff Theory

(assets) you have in your life, you got it from either:

through credit cards or loans (liabilities) or

parents, siblings, or friends (investors’ equity) or paying for the stuff yourself through money you earned (retained earnings equity)

Figure 4.3 Dr Dopson’s Stuff Theory

Television Hand-me-down from sister

(investor) Car Car loan

Computer Credit card Clothes Credit card Food Income (money you earned) Couch and chair Credit card

Kitchen knives Credit card School books Money from parents (investors) Bed Bed from home your parents

Why a Balance Sheet Balances –

Dr Dopson’s Stuff Theory

tense) your stuff

you got it

preparing their balance sheets

equity (how they got their stuff)

Components of the Balance Sheet

the broad headings of

accountants to make information more easily accessible

to readers of the balance sheet and to allow for more

rapid identification of specific types of information for

Current Assets

expected to be sold or turned into cash within one year

can be converted to cash in a short period of time (less than 12 months)

order of their liquidity, include:

Current Assets

cash refers to the cash held in cash banks, money held

in checking or savings accounts, electronic fund

transfers from payment card companies, and

certificates of deposit (CDs)

as stocks and bonds that can readily be bought sold

and thus are easily converted to cash

from other companies These are not to be confused

with a company’s stocks that are listed on its balance

Current Assets

owed to a business by others (such as customers)

been subtracted out) are those monies owed to the

business after subtracting any amounts that may not be collectable (doubtful accounts)

value of food, beverages and supplies used by a

restaurant, as well as sheets, towels and the in-room

replacement items (hangers, blow dryers, coffee

makers and the like) used by a hotel

be used within a year’s time, but which must be

completely paid for at the time of purchase

Current Assets

be readily sold for cash

(customers), but not as easily as converting marketable securities to cash

and the money must be collected

Current Assets

because once paid, refunds for this money are very

difficult (if not impossible) to receive

to the business for more than one year (for example a

three year pre-paid insurance policy) should be listed on the balance sheet as “Other Assets.”

Non Current (Fixed) Assets

which management intends to keep for a period longer than one year, and typically include investments,

property and equipment (land, building, furnishings and equipment, less accumulated depreciation), and other

assets

business which management intends to retain for a

period of time longer than one year, unlike marketable

Non Current (Fixed) Assets

furnishings and equipment, usually make up a

significant portion of the total value of a hospitality

business and are another form of non-current asset

These are listed on the balance sheet at their original

cost less their accumulated depreciation

includes items that are mostly intangible, including the

value of goodwill (the difference between the purchase price of an item and its fair market value)

reduced in value) over the period of time in which it will

be of benefit to the business

business that will be repaid within a year

liabilities include notes payable, income taxes payable, and accounts payable

consist of payables resulting from the purchase of food, beverages, products, services and labor

Liabilities

long-term debt are also considered a current liability

hotel that reserves a ballroom for a wedding to be held several months in the future) are also listed as a current liability (because these monies are held by the business but have not been earned at the time the hotel accepts the deposit)

income taxes that are due but not yet paid will also be

included in this liability classification

business that will not be completely paid within the

current year

lease obligations, and deferred incomes taxes resulting from the depreciation methodology used by the

Owner’s Equity

identifies non-owner (external) claims against the

business’s assets, the owners’ equity portion identifies

the asset claims of the business’s owners

the balance sheet reflects that single ownership

partner’s share is listed on the balance sheet

entry that represents the number of shares of stock

issued (owned) multiplied by the par value (the value of the stock recorded in the company’s books)

Owner’s Equity

of its current selling price

value for the stock they issue and as each share is sold,

an amount equal to the par value is reported in the

common stock section of the balance sheet

reported in the paid in capital portion of the balance

sheet

Owner’s Equity

company, the value of each type should be listed

separately on the balance sheet

equity portion of the balance sheet

account of profits over the life of the business that have not been distributed as dividends

section may be a negative number

Balance Sheet Analysis

accountants use a variety of methods to analyze the

information it contains

Vertical Analysis of Balance Sheets

horizontal techniques In very similar ways, the balance sheet can be reviewed using these same techniques

business’s Total Assets take on a value of 100%

100%

Figure 4.8 Vertical (Common Size) Balance Sheet Analysis

Blue Lagoon Water Park Resort Balance Sheet

Less Accumulated Depreciation 4,668,900 10.0 Net Property and Equipment 32,623,150 70.2

Total Current Liabilities 4,022,600 8.6 Long-Term Liabilities

Vertical Analysis of Balance Sheets

categories are expressed as a percentage (fraction) of

Total Assets Individual liability and owner’s equity

classifications are expressed as a percentage of Total

Liabilities and Owner’s Equity

number, which is why this type analysis is sometimes

referred to as common-size analysis

compare a unit’s percentages with industry averages,

other units in a corporation, or percentages from prior

periods

Horizontal Analysis of Balance

Sheets

information is the horizontal analysis method

analysis of a balance sheet requires at least two

different sets of data

analysis technique is also called a comparative

analysis

Horizontal Analysis of Balance Sheets

balance sheet may be concerned with comparisons

such as their:

business units

Figure 4.9 Horizontal (Comparative) Balance Sheet Analysis

Blue Lagoon Water Park Resort Balance Sheets December 31, 2009 and 2010

Total Liabilities 19,778,705 18,600,000 (1,178,705) (6.0)

Determining Variance

previously experienced levels, and will give you an

indication of whether your numbers are improving,

declining, or staying the same

balance sheet can be calculated in the same way

listed on two different balance sheets is easy to

compute and is always the numerator in any percentage change (variation) calculation

g o fig ure!       

To calculate the variance in cash, you would use the following formula:

Cash This Year – Cash Last Year = Variance

or

$2,314,750 - $2,370,800 = ($56,050)

Effective managers are also interested in computing the percentage variance, or

percentage change, from one time period to the next Thus, the cash percentage variance is determined as follows:

(Cash This Year – Cash Last Year)

or ($2,314,750 - $2,370,800)

( g o fig ure! continued)       

Of course, an alternative and shorter formula for computing the percentage variance is as follows:

Cash This Year

or

$2,314,750

$2,370,800 – 1 = (2.4%)

Inflation Accounting

the preparation of balance sheets (as well as other

financial documents) is because the value of money

changes over time

know well, if you don't adjust for inflation (the tendency for prices and costs to increase) just about everything is more expensive today than it was 30 years ago

Inflation Accounting

(the tendency for prices and costs to decrease),

managerial accountants must know how to properly

consider them when comparing financial data from two different time periods

that can be bought) of money is likely diminished over

time due to the effects of inflation

accounting) can be very complex

Review of Learning Outcomes

sheet for a hospitality business

prepare a balance sheet

financial condition of your own business