Question

This week we discuss the properly classified Balance Sheet. Recall that the value of assets is based on historical cost with few exceptions (short-term investments). Liabilities include values based on terms like "likelihood" and "estimatable". So how reliable is the Balance Sheet?

Please read this weeks lesson and respond to these questions, in your own words.

Do you feel that the balance sheet would be more accurate if accountants were allowed to use fair value when placing asset values on the balance sheet? What are the pros and cons of each?

Could a company show a profit and still be short of cash? How so?

Most financial statement readers believe that property, plant, equipment, and intangible assets (most notably goodwill) are the most misstated assets on the balance sheet. Why?

Answer 1

This week we discuss the properly classified Balance Sheet. Recall that the value of assets is based on historical cost with few exceptions (short-term investments). Liabilities include values based on terms like "likelihood" and "estimatable". So how reliable is the Balance Sheet?

The balance sheet is a statement which is as on date, it means it has cumulative balances and not for the period (year) like profitability statement, the assets such as fixed assets, investments are usually based on historic cost and not fair market value as the assets are meant to be used as going concern basis. Similarly, liability are based on likelihood and estimable as the exact amount of liability in some cases may not be estimable hence an approximate amount is recorded. The balance sheet is reliable there may be minor differences from actual assets /liability realized.

Do you feel that the balance sheet would be more accurate if accountants were allowed to use fair value when placing asset values on the balance sheet?

Some accounting standards require fair value measurement for certain assets and liabilities however not for all assets as recording assets at market value means realizing profit/loss which has not occurred hence the assets/liability are carried at historical cost with some exceptions

What are the pros and cons of each?

The recording of assets and liabilities at historical cost may mislead the readers especially when there is obsolescence of the asset in the market however stating the asset at fair inflated value shall also mislead the users

Could a company show a profit and still be short of cash? How so?

The cash in the balance is the year end status, however profit pertains to full year hence it is highly possible that company has good profits during the year but has low cash/bank balance at the end of the year

Most financial statement readers believe that property, plant, equipment, and intangible assets (most notably goodwill) are the most misstated assets on the balance sheet. Why?

The goodwill is an intangible fictious asset which comes into existence when the company purchases another company and pays for its repute. The plant, property and equipment are stated at the historical cost in all years until disposed off or fully depreciated as the assets used in business for running the company as a going concern hence the market value would not be important