In part one of this article, we looked at the current assets and liabilities that are typically shown in published balance sheets. In this part, we look at the long term assets and liabilities that appear in the typical balance sheet. Long term assets are items that are not intended for resale, and are used in carrying on the day-to-day operations.
Property, Plant and Equipment: Land and buildings fall under property; machinery and facilities used to produce what the business sells constitute the plant; and tools such as computers come under equipment. Heavy industries like machinery manufacturers need substantial assets under this category while service businesses require much less.
Goodwill: Goodwill is an accounting item rather than a physical asset. It appears when a business has been purchased by its present owners at a price that is in excess of the book value of business’ net assets, i.e. assets less liabilities taken over. It is usually amortized over a number of years by writing off yearly amounts each year as expense, e.g. 1/40th of the total every year for 40 years.
Long Term Investments: These are investments which the company intends to hold for more than a year, such as stocks and bonds of other companies, real estate and such other investments not meant for regular operations. These will be shown at market value if that value is lower than acquisition cost.
Intangibles: Intangibles represent assets such as patents, trademarks, brand names and other such items that cannot be touched or seen, but have value for the business.
Deferred Long Term Expenses: These are expenses such as a heavy advertisement campaign that is expected to produce results over the long term, and hence written off as expense over a number of years instead of the year of incurrence.
Other Long Term Assets: Any other asset that is expected to provide value for a period exceeding one year, including long term notes, i.e. debts, due to the company.
After long term assets comes the long term liabilities, which are amounts payable by the company after one year or more.
Long Term Debt: These are borrowings like a mortgage which the company will pay off over a number of years. These are typically raised to create long term assets and should reduce from year to year unless new long term facilities have been created. Long term debt imposes an interest burden and too much debt and consequent heavy interest payments can eat into the working capital available for operations.
Other Liabilities: Other amounts payable after more than one year are included under this category, which can include amounts borrowed from subsidiary or parent companies in the same business group, and deferred tax payments that might be under dispute.
The final item in the balance sheet is owner’s equity (or shareholders’ equity if the organization is a company). Equity is computed by deducting liabilities from assets, and it will be negative if liabilities exceed assets. Equity is represented by stock, which is cash brought in by owners, and retained earnings, which are undistributed profits. If the company has been incurring losses, retained earnings can become negative and can even completely wipe out the value of stock.
Equity items can appear in the balance sheet under different headings as shown below.
Preferred Stock: Preferred stock represents the cash brought in by a group of shareholders who have a priority for dividends and repayment of capital. Preferred stock might be redeemable after a number of years, or non-redeemable.
Common Stock: Common stock represents the par value of shares acquired by ordinary shareholders who are entitled to all that remains after other stakeholders have been paid. Any additional amounts over the par value paid in by share holders for buying the shares is known as share premium, and is shown separately.
Retained Earnings: Retained earnings are the profits that the company has not paid out as dividends to owners. Such retention occurs when the company needs the amounts to finance expansion or to meet shortfalls in working capital needs.
Reserves: Undistributed earnings can be moved to special purpose reserves to indicate that they are not available for paying out as dividends.
Capital Surplus: Share premiums and such items not built up through retained earnings are shown under this heading.
Minority Interest: Minority interest represents the ownership rights of minority shareholders in subsidiary companies, and is shown when the company integrates the subsidiary’s assets and liabilities into its own balance sheet.
Treasury Stock: Companies can purchase their own shares from the market or individual shareholders. Such repurchased shares can be retired or held for reissue later to raise cash. When the latter option is chosen, the repurchased shares appear in the balance sheet as treasury stock.
In a separate article we will look at balance sheet analysis that seeks to glean meaningful information from the items discussed in parts one and two of this article.
