Now that we have a big picture idea about the balance sheet and income statement, it's time to get more specific. As we take a closer look at the balance sheet, it's still important to understand that the balance sheet conceptually is a substitute attribute for a company's position at a given point in time. A common way to characterize the balance sheet is to imagine you're taking a photograph of the company. On March 31, you take a picture of the company and what you see is the balance sheet of the company as of March 31. You take another picture of the company on December 31, and what the photo displays is a balance sheet as of December 31. What we'll do now is take a magnifying glass and focus on the details of the photograph and we'll start by examining some common assets found on the balance sheet. The last time we saw Missy she showed us some of her delicious creations. This time we're going to see what's behind the counter in search of assets. Remember assets are economic resources owned by the company. We can also think of assets as items that are expected to provide the company future economic benefit. As Missy gives us a tour, jot down those items you considered to be assets. So, Missy what do we have here? This is our dry storage. Mostly our canned goods and anything that doesn't need to be refrigerated. Okay, and these are all things that you use in the baking process. Right. Our yeast and our juices and like our canned fruit. What's that behind you? Behind us is our bags of flour and sugar, and by 50 pound bags of flour and sugar. We probably go through about 150 pounds of sugar every three to four days. That's a lot of sugar. That's a lot of sugar. Okay. Well, let's move on. What's next? All right so Missy, what do we have here? This is our 20 quart mixer. 20 quart mixer? What do you do with this 20 quart mixer, what kind of things do you make? We make small batches of cookies, all of our cake batters. Okay. So you said cookies? When you say a small batch. How many cookies are we talking? We usually judge the batches by pounds of fat and in pounds of batter. You can put about three to four pounds of batter at least at once. Okay. Sounds great. Okay. Let's move on. What next? All right. So if that was the mini mixer, what is this? This is the 60 quart mixer. 60 quart mixer? And so, what do you make with this thing? We make our buttercreams in this mixer. We make our larger batches of cookies. OK. So larger batches of cookies. The last one was a smaller batch and that was about three or four pounds. What are we talking about here? We are talking at least twice as much, usually seven to eight pounds. How many cookies do you think you can get out of that? I think out of that batch of sugar cookie dough, you can get 520 cookies. 520 cookies. I love this machine. All right. Let's move on. What next? All right, so what is this? These are a convection ovens. OK, convection ovens. What do you do here with your convection ovens? We do all of our baking. All of our cakes, all of our cookies, all of our pies, all of our tarts. Everything in this ovens. All right, now it looks like you've had this up in a while, how long have you have you oven? I've had the oven for five years. The previous owner I'm not even sure how long she had it. So, it's pretty old. Okay. Now, you've mentioned that you had some ideas about whether you might replace it or repair it? Right, I think next time one of these breaks down, we're going to have to decide whether we spend the money on a new oven with a warranty or whether we get this one fixed. Probably it has a lot to do with how much it's going to cost to replace a motor or a fan. Okay. Well, ma'am buying those cookies, I think it's still working. Alright. What's next? Alright. We're in the refrigerator here and it's a little cold. Real cold. So what do we have here? These are all of our doughs and batters. Okay. So these are cookie doughs. Cookies doughs, muffin batters. Okay. Wonderful, and there are some other things over here. This would be... All of our milk, and all of our eggs, and all of our butter. So this is more ingredients that you would use in making your doughs and batters? Yeah. All right. Wonderful. Well, I'm freezing. Me too. Let's find another place. Thanks. All right what do we have here? It looks like it sprinkles sprinkles and more sprinkles. These are all of our sprinkles for all the holidays. Decorating all the cookies, and the cakes. Okay. So how long did it take you to accumulate all of these sprinkles. Probably about a year. All right. Well they all look wonderful. All right. So let's move on now to the refrigerator. Great. All right. Walking through Missy's store, we saw several things that we might classify as assets. But there's a problem, we don't see any line item on the balance sheet called flour or cupcakes or refrigerator or oven. No, instead we see a list of line items whose names aren't nearly that descriptive, accounts receivable, inventory or property plant and equipment. This is a good time to mention the idea of standardization. Standardization in financial statements, emphasizes what an item is economically over what it is practically. Let's say we want to compare the position of Sweet Indulgence to that of Body&Soul. Remembering that the balance sheet is really a substitute attribute for a company's position, we can accept that its purpose is not to provide a detailed list of everything the company has. When we consider the line item, inventory, which is defined as a good acquired or manufactured in order to be sold. Then financial statements aren't concerned that the good is a cupcake or a pair of shoes. Economically, a cupcake labeled as inventory on the balance sheet of Sweet Indulgence, makes it comparable to the pair of shoes labeled as inventory on the balance sheet of Body &Soul. So inventory is one common asset we see listed on the balance sheet and we have defined inventory as an item a company manufacturers or acquires for the purpose of selling it. However, when I mentioned Missy's cupcakes is inventory versus Jed's pair of shoes, you should recognize that Missy's cupcakes are manufactured inventory while Jed's shoes are acquired inventory. When you see the value of inventory presented on the balance sheet, the value presented for both the manufactured and acquired inventory represent the cost of the inventory. But companies who manufacture inventory often display three different categories of inventory, either on the balance sheet or included in additional notes that accompany the financial statements. Although not so directly by Missy, the flour and eggs will ultimately make its way into the baked goods that will be sold. Hence, the balance sheet often presents the cost of these items as raw materials inventory. Next, the cost of labor must be added to the raw materials so as the dough is prepared, the cost of raw materials is removed from raw materials inventory and along with labor cost is added to the work in process inventory. Finally, once the goods are finished, they are moved from work in process inventory into finished goods inventory. So the balance sheet for manufacturer might display the three categories of inventory where the raw materials inventory is the cost of the ingredients on hand. The work in process presents the cost of the dough on hand and the finished goods inventory presents the cost of baked goods that are on hand at the balance sheet date. I want to emphasize three additional thoughts before we go on. First, the three classifications of manufactured inventory are the same across manufacturers. So for a car manufacturer, you might find the cost of steel and other components presented as raw materials inventory. The cost of partially constructed cars as work in process inventory, and the cost of the completed vehicle as finished goods inventory. Second, notice that Missy purchased flour and eggs from a supplier and included those items in raw materials inventory. However, those same flour and eggs were included in the suppliers of finished goods inventory. The point being that what determines whether a company presents an item as raw materials inventory or finished goods inventory depends on what the company is in the business to sell. Third, the balance sheet lists inventory as an asset but more precisely classifies inventory as a current asset. By classifying an asset as current, the expectation is that the asset will be converted to cash or used up within one year. Okay. Here's a question for you to answer before we move on. Now let's look at some other current assets typically found on the balance sheet. Cash represents the amount of cash held, say in a register or a vault along with cash balances and bank accounts. Sometimes a balance sheet will include marketable securities which represent investments that can be converted to cash quickly. Prepaid expense represents a payment the company made in advance of incurring the expense. An easy example is if you pay monthly rent at the beginning of the month, you expect to receive the future benefit of using the space for the next month. Lastly, I will mention accounts receivable. And we'll take a closer look at this account. Accounts receivable isn't difficult to grasp conceptually. It merely represents the amount the company is owed by its customers who purchased goods or services on account or for credit. Why am I singling it out? Well, let's take another look at how it's presented on the balance sheet. You see this settled, less allowances for doubtful accounts, that warrant some discussion. Remember our definition of an asset as an item expected to provide future economic benefit. For accounts receivable, a company only expects to receive the future economic benefit if it expects the owing customer to actually make payment. Unfortunately, it's rare for a company to have all of its customers make full payment on the amount owed. So the accounts receivable recorded as an asset should only be for the amount of total accounts receivable, the company expects to receive. The amount the company is owed by customers that it estimates it will not receive is called the allowance. Which is short for allowance for doubtful accounts. I bring this up here because this is my first opportunity to highlight an often overlooked fact about financial statements. Financial statements are full of estimates that the company makes about its position and its performance. This notion will come up again but for now be aware that while estimates are not all bad, they can show up in unexpected places. In our next lesson, we'll see more examples of estimates in the financial statements as we return to Missy's bakery to look more closely at non-current assets. It's always good to get back to the bakery. Until next time, be well.
