Topic 3: Balance Sheet

Sections:

I. Overview
II. Individual Items

I. Overview

Balance sheet shows the financial condition of a firm on a particular date. Most firms use
the calendar year which ends on December 31. Some firms use a fiscal year ending on a
date other than December 31.

Assets (liabilities) are normally divided into two mutually exclusive categories: current
and non-current or long-term assets (liabilities). Being current means that the item is
expected to be converted into cash (paid out) within one year or one operating cycle,
whichever is longer.

The operating cycle covers the time between the acquisition of inventory and the
realization of cash from selling the inventory. Most firms have an operating cycle that is
less than one year.

The usual problems associated with the reported balance sheet are:
1. The amounts at which assets and liabilities are measured may be outdated (recorded at
historical costs).
2. Some assets and liabilities are not recorded, i.e., off-balance-sheet.

Sometimes, the second problem can be serious.

II. Individual Items

The following balance sheet is retrieved from Intel’s 2005 10-K.

Intel Corporation
Consolidated Balance Sheet
December 25, 2004 and December 27, 2003 2004 2003
(In Millions—Except Par Value)

Assets
Current assets:
Cash and cash equivalents $ 8,407 $ 7,971
Short-term investments 5,654 5,568
Trading assets 3,111 2,625
Accounts receivable, net of allowance for doubtful accounts of $43 ($55 in 2003) 2,999 2,960
Inventories 2,621 2,519
Deferred tax assets (Kevin: Prepaid) 979 969
Other current assets 287 270

Total current assets 24,058 22,882

Property, plant and equipment, net 15,768 16,661
Marketable strategic equity securities 656 514
Other long-term investments 2,563 1,866
Goodwill 3,719 3,705
Other assets 1,379 1,515

Total assets $ 48,143 $ 47,143

Liabilities and stockholders’ equity

Current liabilities:
Short-term debt $ 201 $ 224
Accounts payable 1,943 1,660
Accrued compensation and benefits 1,858 1,559
Accrued advertising 894 716
Deferred income on shipments to distributors 592 633
Other accrued liabilities 1,355 1,302
Income taxes payable 1,163 785

Total current liabilities 8,006 6,879

Long-term debt 703 936

Deferred tax liabilities 855 1,482
Commitments and contingencies (Notes 17 and 18)
Stockholders’ equity:
Preferred stock, $0.001 par value, 50 shares authorized; none issued — —
Common stock, $0.001 par value, 10,000 shares authorized; 6,253 issued and outstanding
(6,487 in 2003) and capital in excess of par value 6,143 6,754
Acquisition-related unearned stock compensation (4) (20)
Accumulated other comprehensive income 152 96
Retained earnings 32,288 31,016

Total stockholders’ equity 38,579 37,846

Total liabilities and stockholders’ equity $ 48,143 $ 47,143

Current assets usually include cash, marketable securities, short-term receivables,

inventories, and prepaids.

Cash

This includes cash on hand, negotiable checks, and unrestricted balances in checking
accounts.

Marketable Securities (Short-Term Investments)

Securities that are temporarily invested and are expected to be converted into cash during
the current period (< 1 year) to earn a return. They must be relatively riskless securities
and highly liquid. They are reported at fair values.

Trading Securities

They are securities held for resale in the short term. They are shown at fair values.

Accounts Receivable

Monies due on accounts that arise from sales or services rendered to customers.
Inventory

Inventories are the balance of goods on hand. They include raw materials, work in
progress, and finished goods.

Prepaids

They are the expenditures made in advance. They include prepaid advertising, prepaid
prescription, prepaid taxes, prepaid insurance, etc.

Long-term assets usually include four categories: tangible assets, investments, intangible
assets, and other.

Tangible Assets

They include land (shown at acquisition cost), buildings (shown at cost plus the cost of
permanent improvements, subject to depreciation), machinery (shown at historical cost
plus delivery and installation costs, subject to depreciation), and construction in progress
(shown at cost; this will be transferred to the proper tangible asset account upon
completion of construction).

Accumulated Depreciation

This account accumulates the depreciation expense taken each period. This amount is
subtracted from tangible assets to arrive at the book value of tangible assets.

Capital Leases

When a lease is, in substance, a purchase, the lease is classified as a capital lease and
recognized as a long-term asset. This amount is shown net of amortization.

For leases that are not purchases, they are classified as operating leases.

Investments

Long-term investments, usually stocks and bonds of other companies, are often held to
maintain a business relationship or to exercise control. Equity investments are shown at
fair values. Debt securities are carried at amortized cost.

Investments can also include tangible assets that are not currently used, such as an idle
plant.

Intangible Assets

Goodwill arises when one firm acquires another firm for a price in excess of the fair
market value. Goodwill is not amortized, but is subject to annual impairment reviews.
This is usually the most important item among intangible assets for analytical purposes
because of its potential impacts on the balance sheet.

Other intangible assets include patents, trademarks, franchises, copyrights, etc. They are
recorded at cost and amortized over time.

Current liabilities usually include payables (accounts payables, wage payables, taxes
payables, notes payables), unearned income, and other current liabilities.

Accounts Payable

This arises from trade credit extended by suppliers.

Notes Payable

Notes payable are short-term obligations in the form of promissory notes (line of credit,
etc.) to suppliers or financial institutions.

Current Maturities of Long-Term Debt

When a firm issued bonds or other forms of long-term debt, the proportion of the
principal that will be paid during the upcoming year is recognized as a current liability.

Accrued Liabilities

Under the accrual principle, accrued liabilities result from the recognition of an expense
in the accounting records prior to the actual payment of cash. Accruals can arise from
salaries (wage payable), rent, advertising expense, compensation and benefits, insurance,
taxes, interest expense, etc.

Unearned Income

Payments collected in advance of the performance of service, e.g., rent income and
subscription income.

Long-term liabilities include notes payable (some firms use this term for non-current
notes), bonds payable, deferred taxes, warranty obligations, capital lease obligations,
commitments and contingencies, etc.

Deferred Taxes

Deferred taxes are the result of temporary differences in the recognition of revenue and
expense for taxable income relative to reported income. Recall that a firm may choose
different accounting methods for tax purposes and reporting purposes. Deferred taxes
could be a mixture of current and non-current liabilities.
Warranty Obligations

This estimate arises out of product warranties.

Capital Lease Obligations

When a lease is, in substance, a purchase, an asset and a liability are recorded on the
balance sheet equal to the present value of the lease payments to be made (subject to
amortization).

Commitments and Contingencies

Commitments are contractual agreements that will have a financial impact in the future.

Contingencies are potential liabilities such as possible damage awards assessed in

lawsuits.

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Veil:

Many firms use financing schemes such as product financing arrangements, sales of
receivables with recourse, joint ventures, etc., to obtain financing needed without
recognizing related assets and liabilities. This type of off-balance-sheet financing
activities is often scattered in notes, and needs to be put together piece by piece.
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Shareholders’ equity includes common stock, additional paid-in capital, retained

earnings, preferred stock, accumulated other comprehensive income, and treasury stock.

Common Stock

The amount of capital from original sales of stock shares based on the par or stated value
of the shares issued.

Additional Paid-in Capital

This is the amount of capital by which the original sales of the stock shares exceeded par
value.

Retained Earnings

Retaining earnings are the undistributed earnings of the firm.

Preferred Stock

Preferred stock usually carries a fixed dividend payment.

Accumulated Other Comprehensive Income

This account accumulates each period’s other comprehensive incomes (Recall from Topic
2, there are currently 4 items).

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Minicase 3-1:

Delta Air Lines is the nation’s third largest carrier. The company has been operating in a
harsh environment since September 11, 2001. In September, 2004 the firm announced to
cut 6,000 to 7,000 jobs to avoid a bankruptcy filing. In a memo to Delta’s employees,
one top official stated that “we must review our options to survive, to make certain that
we are doing what we can to keep this airline going.”

Required Tasks:

1. Obtain 2000-2004 (5 years) consolidated balance sheets for Delta Air Lines. Prepare
common-size balance sheets.
2. What do you observe? Is there a trend in the asset, debt, and equity structure of Delta
Air Lines?
3. If you were an investor, a creditor, or a supplier of Delta Air Lines, what concerns
would you have? Why?

The group report is due in one week.

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