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Essay: The Accounting Balance Sheet

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The Accounting Balance Sheet

The Accounting Balance Sheet

The accounting balance sheet is one of the major financial statements used by accountants and business owners. It is also referred to as the statement of financial position.
Since the balance sheet informs about a company’s financial position as of one moment in time, it allows seeing what a company owns as well as what it owes to other parties as of the date indicated in the heading. In this way for example the banker is helped to determine whether or not a company qualifies for additional credit or loans.
Other who would be interested in the balance sheet includes potential investors, suppliers, customers, and government agencies.

The major components of the balance sheet are: – Assets – Equity – Liabilities.

– Assets: are resources that the company owns that have been acquired through transactions and have future economic value that can be measured. Assets are divided in Non-current assets and current assets.
– Non current assets: assets detained for a long term; for example buildings
Intangible and tangible non-current assets: intangible assets are resources of an entity, but have no physical existence; they derive their value from intellectual or legal right. For examples, limited-life tangible assets are copyright and patents, while intangible assets with unlimited life are trademarks. They are reported at the cost on the balance sheet. Tangible assets are resources with physical existence, for example inventory. They can be used as a collateral to raise loans and can be more readily sold to raise cash in emergencies.
Valuing assets on the balance sheet: the valuation of assets is the process of estimating the market value of a financial asset. Valuations are needed for many reasons such as investment analysis, capital budgeting, and merger or acquisition transactions. These valuation rules are based on international accounting standards. The historic cost convention holds that the value of tangible non-current assets should be based on their acquisition cost. However they will be used up over time and the amount used up, which is referred to as depreciation, must be measured for each year. The total depreciation that has accumulated over the period since the asset was acquired must be deducted from its cost, and the net value is referred to as the carrying amount. In this way we don’t go against the historic convention but we recognise that a part of the historic cost has been consumed over time. An alternative to this method is the Fair value, where fair value is the amount at which the asset could be bought or sold in a current transaction between parties, other than in a liquidation sale. This is used for assets whose carrying value is based on market-to-market valuations. The use of fair value, instead of the depreciated cost, can provide users with more information, which may be more relevant to their needs.
Impairment of assets: it can be explained as a sudden or unexpected decline in an asset. This might result from changes in market conditions, technological obsolescence, and so on. An impairment loss is the amount by which the carrying amount of an asset exceeds it recoverable amount. When this occurs, the asset value is said to be impaired and the general rule is to reduce the value on the statement of financial position to the recoverable amount, unless is done, the asset value will be overstated.
Depreciation methods: depreciation is used for assets whose life is not indefinite; it is the allocation of the cost of the asset that has been used up in generating the revenue recognised during a particular period. The depreciation charge is considered to be an expenses of the period to which it relates. Only two method are commonly used in practice; the fist one is the straight-line method, that depreciates cost evenly through out the useful life of the fixed asset. Depreciation per annum = (Cost – Residual Value) / Useful life. Where – Cost includes the initial an any subsequent capital expenditure – Residual Value is the estimated scrap value at the end of the useful life of the asset – Useful Life is the estimated time period an asset is expected to be used It must be observed that this method not represent the current market value, which may be quite different. The second method is the reducing-balance method, which charges the depreciation at a higher rate in the earlier years of an asset. Since it applies a fixed percentage rate of depreciation, the amount of depreciation reduces as the life of the asset progresses. Depreciation per annum = (Net Value – Residual Value) x Rate% . Where – Net Value is the asset’s net value at the start of an accounting period – Residual Value is the estimated scrap value at the end of the useful life of the asset – Rate of depreciation is defined according to the estimated pattern of an asset’s use over its lifetime.
It should be choose the method that best matches the depreciation expense to the pattern of
economic benefits that the assets provide.

Depreciation of tangible and intangible non-current assets: if an intangible asset has a finite life, the approach is more or less the same as for the tangible assets. (When we consider intangible assets we should say ‘amortisation’ instead of ‘deprecation’). However some differences occur; due to the valuation problems surrounding these assets, the residual value of an intangible asset is normally assumed to be zero.
– Current assets: assets detained for the short term, that are expected to turn to cash or to be used up within one year of the balance sheet date; for example inventory.
Costing inventories (FIFO and weighted average cost): in order to determine the cost of the inventories sold during the period and the cost of the inventories at the end of the period, some assumptions must be made about the way in which the inventories are physically handled. These assumption are concerned only with providing useful accounting information. One assumption is fist in first out (FIFO); under FIFO, the cost of goods sold is based upon the cost of material bought earliest in the period, while the cost of inventory is based upon the cost of material bought later in the year. During periods of inflation, the use of FIFO will result in the lowest estimate of cost of goods sold among the different approaches, and the highest net income. Another assumption is the weighted average cost. Under this assumption, both inventory and the cost of goods sold are based upon the average cost of all units bought during the period. The different costing methods will only have an effect on the reported profit from one year to the next. Over the life of the business, therefore, the total profit will be the same whichever costing method has been used.
Net realisable value: With regards to inventory, NRV is the estimated selling price in the ordinary course of business minus any cost to compete and to sell the goods. It is one of the amounts considered when determining the lowest cost for items in inventory. This rule means that the valuation method applied to inventories (cost or net realisable value) could switch each year, depending on which of cost and net realisable value is the lower. Net realizable value is also associated with accounts receivable. In this situation, NRV is the amount of accounts receivable that is expected to turn to cash.
Trade receivable: trade receivables are usually current assets that arise from selling merchandise or providing services to customers on credit. Recording the dual aspect of a credit sale will involve increasing sales revenue and increasing trade receivables by the amount of the revenue from the credit sale. With this type of sale there is always the risk that the customer will not pay the amount due. When it becomes reasonably certain that the customer will never pay, the debt owed is considered to be a bad debt and this must be taken into account when preparing the financial statements. Reducing the trade receivables and increasing expenses by the amount of the bad debt must write off the bad debit. The matching convention requires that the bad debt be written off in the same period as the sale that gave rise to the debt is recognised.
– Equity and liabilities:
Equity: is usually defined as the value of the assets contributed by the owners, determined by the total number of shares. This is added to the total income earned and retained by the company to give the company’s total equity value. Shares represent the basic units of ownership of a business. All company issue ordinary shares and the nominal value of such shares is at the discretion of the people who start up with the company, and the total number of shares represents the share capital of the company. The nominal value is not permanent, later the shareholders can decide to change it. Retained earnings is the stockholders’ equity account that generally reports the net income of a corporation from its inception until the balance sheet date less the dividends declared from its inception to the date of the balance sheet.
Liabilities: liabilities are obligations of the company; they are amounts owed to creditors for a past transaction. Along with owner’s equity, liabilities can be thought of as a source of the company’s assets. Liabilities also include amounts received in advance for future services. Since the amount received (recorded as the asset Cash) has not yet been earned. The liabilities are classified as: non-current liabilities and current liabilities. Non-current liabilities are obligations of the enterprise that are not payable within one year of the balance sheet date. Two examples are bonds payable and long-term notes payable. Current liabilities instead are obligations due within one year of the balance sheet date. Another condition is that the item will use cash or it will create another current liability.
Difference between liabilities, provisions and contingent liabilities: – Provision: is a liability of uncertain timing or amount. An entity must recognise a provision if (IAS 37) a present obligation has arisen as a result of a past event, payment is probable and the amount can be estimated reliably. – Liabilities: present obligation as a result of past events, settlement is expected to result in an outflow of resource (payment). – Contingent liability: a possible asset that arises from past events, and whose existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.

Current state
According what we have said before, the Vestas’ balance sheet at 31 December 2013 is divided in two main sections: – assets – equity and liabilities.
Analysing the first section, non-current assets are divided in intangible assets, tangible assets (total property, plant and equipment) and other non-current assets, as we can see in the table below.

Figure 1 Vestas consolidated balance sheet – non-current assets
Goodwill is recognised in intangible assets. It is not amortised, but reviewed for impairment once a year and also if events or changes in circumstances indicate that the carrying value may be impaired. If impairment is established, the goodwill is written down to its lower recoverable amount. The annual report has been redacted using the historic cost method less accumulated depreciation and impairment losses, except for the derivative financial instruments which are measured at fair value and non-current assets held for sale which are measured at the lower of carrying amount and fair value less costs to sell. For property, plant and equipment depreciation is calculated on a straight-line basis over the expected useful lives of the assets, except for land that is not depreciated. The basis of depreciation is calculated taking into account the residual value of the asset less any impairment losses. Also development projects are amortised on a straight-line basis over their estimated useful life, where the amortisation period is three for five years and the basis is calculated net of any impairment losses. For software it’s the same, with a basis over five years. Investments in associates are measured in the balance sheet at the proportionate share of the net asset value of the associates. Receivables from associates are measured at amortised cost. Deferred tax is measured on the basis of the tax rules and tax rates of the respective countries that will be effective when the deferred tax is expected to crystallise as current tax based on the legislation at the balance sheet date. Other receivables principally comprise of VAT and insurance.
If we consider the impairment associated to property, plant and equipment (see appendix xxx), the net impairment loss of EUR 33m is recognised in 2013. This results from the write-down of specific assets due to damage, write-down of factories and adjustments to asset held for sale.
We report now the subsection of the current assets:

Figure 2 balance sheet Vestas – current assets
According to the group accounting policies, Vestas measures the inventories at the lower of cost, using the weighted average cost and the net realisable value (NRV). NRV is determined taking into account marketability, obsolescence and development in the expected selling price. Trade receivable are expected to be received within 12 months and are measured at amortised cost. Company within the energy sector mainly owns them and the credit risk is dependent on the development within this sector. Vestas doesn’t have a single significant trade debtor nor are the trade debtors concentrated in specific countries. Regarding bad debts, provisions are made.

Figura 3 Balance sheet Vestas – equity
We watch now the second section of the balance sheet that includes equity and liabilities.
Beginning with equity, has already said before, it’s consists of share capital and retained earnings. In this case we have to consider also other reserves.
The share capital comprises 203.704.103 shares of DKK 1.00 and except for one increase of 18.500.000 shares in 2009 the share capital has not changed in the period 2008-2013.
As shown in the table below, Vestas has acquired treasury shares amounting to a total of 10% per cent of the company’s share capital during the 2013, this has been done in order to using them for the Group’s incentive programmes.

Figurae4 Vestas Treasury shares overview
The last part of the balance sheet regards the liabilities, which are divided in non-current liabilities and current liabilities.

Figurae5 Vestas balance sheet – liabilities
According to the group accounting policies, provisions are recognised when as a consequence of a past event the company has a legal or constructive obligation and it is probable that there will be an outflow of the Group’s financial resources to settle the obligation. At the start of the warranty period, calculated provisions are made for each type of wind turbine and are released to the income statement over the warranty period as warranty costs are incurred. Subsequently, periodic reviews are performed based on an overall assessment of the need for provisions. Lack of reliability in several of Vestas’ products has previously led to major warranty provisions. In recent years, Vestas has invested significant resources in improving the products and increasing their reliability. This work comprises design, production, installation and continuous maintenance.
The goal of these initiatives is to reduce Vestas’ warranty costs, to secure customer returns, to increase the competitiveness of the products and to improve customer earnings

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