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C. Choose the correct form of the Verbals.
Figures (appearing/appeared) in balance sheet represent the historical value of the stock of assets available to the firm (to generate/generating) sales and profits. Because the value of assets is (base/based) on original purchase price they tend to understate the real value of these assets if they had to be (replacing/replaced). In high inflationary periods, the cost of replacing (existing/existed) assets is relatively high. As a result, by (understating/having understated) the value of these assets, the returns on these assets become (overstating/overstated). Attempts have been made (state/to state) assets on a replacement basis, but accountants have been unable to resolve this problem to everyone’s satisfaction.
Generally (spoken/speaking), however, the balance sheet is a statement of assets, liabilities, and stockholders’ equity. As of a certain date, the left side on this statement shows a breakdown of current assets in the form of cash and other assets that (constituting/constitute) the working capital of the firm. Fixed assets are mainly long-term investments, including plant and equipment.
The right side of the balance sheet shows current liabilities, (consisting/consisted) of accounts payable, notes payable, and other short-term liabilities. From this point on you find long-term debt, which has a maturity date of over 1 year. This part of the balance sheet may also include the capitalized value of financial leases. After you (deduct/deducted) the liabilities from the assets, the (remaining/remained) value is the net worth of the firm. The components of net worth include the par value of common stock outstanding, paid-in capital surplus, and retained earnings (being accumulated/accumulated) from previous profits generated by the firm after the deduction of dividend payments. If the firm were (liquidated/liquidating) and all creditors’ claims (paid off/paying off), the net worth is what would be (left/leave) over for distribution to the stockholders.
By (deducting/deduct) current liabilities from current assets, you can find out something about the liquidity of the firm, and by matching profits against the assets invested in the firm, you can gain some idea of how effectively the firm has utilized assets to generate profits.
d. Test your knowledge by answering the following questions:
1. In the body of a balance sheet, what are the three sections called?
2. Of the two forms of the balance sheet, which form more closely approximates the accounting equation?
3. How can a balance sheet help the firm to spot areas of financial weakness and strength?
4. Why do companies record the original purchase price of assets, and not their (estimated) current selling price or replacement cost?
5. In which systems is replacement cost accounting used?
e. Match the two parts of the sentences:
1. The historical cost principle is that the price paid to buy assets
2. Intangible assets are usually long-term in nature
3. Liabilities are considered to be current liabilities
4. Some thing of value are never shown on a balance sheet
5. When you deduct a company’s liabilities from its assets
a. you are left with shareholders’ funds.
b. and not their current value is recorded in accounts.
c. if the obligation is to be settled within the current accounting period.
d. and lack physical substance.
e. for example the knowledge and skills of the company’s employees.