Corporate Finance For Dummies. Michael Taillard
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and past due but has yet to be written off as uncollectible (which is considered an expense). Usually, the accounts receivable entry looks something like this:
Inventories
The inventories category includes the value of all supplies that a company intends to use up during the process of making and selling something. Inventories include the raw materials used in production, the work-in-process products (partially completed products), end products ready for sale, and even basic office supplies and goods consumed in production (such as stationary used in offices, oil carried on delivery trucks for regular maintenance, and so on).
Income tax assets
Income tax assets include two forms of income taxes. The first is one that many people are familiar with: tax returns. When a company is set to receive money back on its taxes, that money becomes a short-term asset until the company receives it, at which point it becomes cash.
The other form of tax asset is the deferred tax, which occurs when a company has met the requirements to receive a tax benefit but has yet to receive it. For example, a company that experiences losses one year can file those losses the next year rather than the current year, so the value of its losses would be a deferred income tax asset that would decrease any income tax owed the next year.
Prepaid accounts
When a company pays for some expense in advance, the value of that prepayment becomes an asset (called a prepaid account) for which the company will receive services in the future. Consider insurance as an example. If a company prepays its insurance for a full year, the full dollar amount paid will add to the value of the company’s prepaid accounts. Every month, the company decreases
Other current assets
The other current assets category is a rather common one to find on the balance sheet, but it means different things to different companies. Generally, it’s an all-inclusive category for any assets that are expected to turn into cash within a one-year period but that aren’t listed elsewhere on the balance sheet. Other current assets may include restricted cash, certain types of investments, collateral, and pretty much anything else you can think of.
Long-term assets
The long-term assets section includes three main categories — investments, property, plant, and equipment (PPE), and depreciation. I describe each of these in more detail in the following sections.
Investments
Long-term investments typically include equities and debt investments held by the company for financial gain, for gaining control over another company, or in funds such as pensions. It can also include facilities or equipment intended for lease or rent. In any case, all the investments in this section are meant to be held for more than one year.
Note: Sometimes a company lists its bond investments as notes receivables, which are reported sort of like accounts receivables, except with the expectations of receiving payments in the long term.
Property, plant, and equipment
The property, plant, and equipment (PPE) category includes nearly every major physical asset a company has that it will use for more than one year. Buildings, machinery, land, major furniture, computer equipment, company vehicles, and even construction-in-progress projects all qualify as PPE. Basically, if you can touch it and plan to use it for more than a single year, it contributes to the value of PPE.
Depreciation
The long-term physical assets included in PPE don’t last forever. With age and usage, every long-term physical asset is subject to depreciation, or a decrease in value. Different companies measure depreciation in different ways (some of which I discuss later in this section), but regardless of the manner in which a company measures depreciation, the total shows up on the balance sheet as a subtraction from the total value of PPE. It looks something like this:
A company may choose to leave out the gross PPE line because it doesn’t contribute anything to the value of the total assets (and because you can calculate it easily, given the other information listed).
What follows are two of the most common methods for calculating depreciation.
Straight-line and unit-of-production depreciation
The easiest type of depreciation to use is called straight-line depreciation. Straight-line depreciation is cumulative, meaning that if you report a value in depreciation for a piece of equipment one year, that same amount gets added to the next year’s depreciation, and so on, until you get rid of the equipment or its value drops to 0.For example, if you buy a piece of equipment for $100 and each year it has a depreciation of $25, then you’d report $25 of accumulated depreciation the first year and $50 of accumulated depreciation the next year, while PPE value would go from $100 the first year to $50 the next.
A similar type of depreciation, called unit-of-production depreciation, replaces years of usage with an estimated total number of units that the equipment can produce over its lifetime. You calculate the depreciation each year by using the number of units produced that year.
SUM OF YEARS DEPRECIATION
The sum of years method for calculating depreciation applies a greater value loss at the start of the equipment’s life and slowly decreases the value loss each year. This method allows companies to take into account the marginally decreasing loss of value that most purchases go through.
To see what I mean, imagine that you’re buying a new car. Unless you get into an accident or otherwise damage the vehicle, the car itself will never lose as much value during its lifetime as it does in the first year. By the time the car is 10 years old, it will have lost most of its value, but it won’t be losing its value as quickly each year.
So if you purchase a piece of equipment for $100,000 and it’s supposed to last for five years with a salvage value of $10,000, then the first year’s depreciation would look like this: