The simplified balance sheet (at left) was shown in my last post (11/29/12). A very important notion is conveyed by the word “Static” at the top. This means that the balance sheet, unlike the income statement (which we will cover soon), is a reflection of the state of the business only at a “point in time”, a specific date, usually at the end of a month, quarter or year. The values of the various components … the assets, liabilities and capital will have changed leading up to this date, but on this date they are frozen as in a snapshot. They are like the photo-finish of a horse race. You know where everything is when the winner hits the wire, but it will require the income statement to learn how they got there. Notice that the capital accounts are clustered in the lower right quadrant with Long-Term Debt in this simplified view. I’ll explain why later.
Now we are going to take a slightly different view … more vertical, top to bottom. As you can see, the top half is labeled as “Current” and the lower half “Non-Current”. As for the asset categories, any item that is expected to be converted to cash within the near term from the date of the balance sheet is considered current. Near term is viewed as the next 12 months. Any asset that will remain in its present form beyond that time frame is treated as long-term. The same time-frame concept governs the treatment of liabilities. If it comes due or is expected to be repaid within the next 12 months, it is current. In the case of instalment loans for example, the next twelve months of payments are considered current (called Current Maturities or Current Portion of Long-Term Debt) and the trailing payments are carried in non-current. While there is a limited amount of discretion, the accounting principle of conservatism calls for any reasonably prepared balance sheet to adhere to this standard.
In my next post we will discuss two additional “bahavioral” characteristics of the balance sheet.
Douglas K. Steele