Chapter 2

The Balance Sheet

Hospitality Industry
Managerial Accounting

Eighth Edition
Questions Answered by the
Balance Sheet
• How much cash was on hand at the end of
the period?
• What was the operation’s total debt?
• What was the mix of financing at the end
of the period?
• How much did guests owe the hotel?
• What amount of taxes was owed?
• Can the operation pay its current debt?
• How much of the operation’s assets do
stockholders own?
Slide 2
The Unique Trait of the
Balance Sheet
• The income statement, the statement
of owners’ equity, and the statement of
cash flows all pertain to a period of
time.
• The balance sheet reflects an
operation’s financial position—its
assets, liabilities, and owners’ equity—
at a given date.
• The balance sheet reflects, or tests and
proves, the fundamental accounting
equation (assets equal liabilities plus
Slide 3
The Current Ratio
• The current ratio is current assets divided
by current liabilities.
• Many long-term loans specify a required
current ratio; failure to meet the
requirement may result in all long-term
debt becoming due immediately.
• Since few operations could raise large
sums of cash quickly, bankruptcy could
result.
• Therefore, management must carefully
monitor the balance sheet to ensure that
the operation is in compliance.
Slide 4
How Different Groups Use
the Balance Sheet
• Aside from the current ratio,
management is usually more interested
in the income statement and
department operations statements than
in balance sheets.
• Creditors look at a hospitality
operation’s balance sheet to determine
its ability to meet current and future
obligations.
• Investors look at the balance sheet for
the financial flexibility needed to pay
Slide 5
Liquidity
• Liquidity measures an operation’s
ability to convert assets to cash.
• Profit alone does not guarantee that
a business will be able to meet its
financial obligations as they become
due.
• Ideally, a business will have sufficient
liquidity both to pay its bills and to
provide its owners with adequate
dividends.
Slide 6
Limitations of the Balance Sheet

1. Valuations of assets are not

current values.
2. Not all assets appear on balance
sheets.
3. The balance sheet is static in
nature.
4. Some valuations are inexact.

Slide 7
Limitation #1: Valuations
• Since the balance sheet is based on the
cost principle, it often does not reflect
current values of some assets, such as
property and equipment. This difference
may be significant.
• Since real estate prices can fluctuate
wildly, the value of property is
particularly vulnerable to inaccurate
valuations.
• A misstatement of the value of a
property’s assets could lead to less
Slide 8
Limitation #2: Omissions
• Balance sheets fail to reflect many elements
of value to hospitality operations.
• The people providing the services are critical
to hotels, motels, restaurants, clubs, and
other hospitality sectors, but the balance
sheet does not reflect the human resource
investment.
• Millions of dollars are spent in recruiting and
training to achieve an efficient and highly
motivated work force, yet this essential
element is not shown as an asset.

Slide 9
Limitation #3: Static Nature
• Balance sheets reflect a property’s
financial position only at a single
moment in time.
• They become less useful as they
become outdated.
• The financial position reflected at year-
end may be quite different one month
later.
• This is particularly true if an operation
makes a major investment in fixed
Slide 10
Limitation #4: Inexactness
Several balance sheet items are based on
estimates:
• accounts receivable—net (estimate of
collectible portion)
• inventory (lower of cost or market)
• property and equipment (cost less
estimated depreciation)
In each case, when the estimates are in
error, the balance sheet items will be
wrong.
Slide 11
Balance Sheet Formats
The balance sheet can be arranged in either
the account or report format.
• The account format lists the asset
accounts on the left side of the page and
the liability and owners’ equity accounts
on the right side.
• The report format shows assets followed
by liabilities and owners’ equity. The group
totals on the report form can show either
that assets equal liabilities and owners’
equity or that assets minus liabilities equal
owners’ equity. Slide 12
Major Elements of the
Balance Sheet

• Assets: current assets,

noncurrent receivables,
investments, property and
equipment (fixed), and other
assets
• Liabilities: current and long term
• Owners’ equity
Slide 13
Current Accounts
• Current assets refers to items to be converted
to cash or used in operations within one year
or a normal operating cycle.
• Current liabilities are obligations that are
expected to be satisfied either by using current
assets or by creating other current liabilities
within one year or a normal operating cycle.
• A normal operating cycle may be a few days or
several months long.
• The hospitality industry commonly classifies
assets as current/noncurrent on the basis of
one year rather than the normal operating
cycle. Slide 14
Typical Components of
Current Assets

• Cash
• Marketable securities
• Receivables
• Inventories
• Amounts due from owner,
management company, or related
party
• Prepaid expenses
Slide 15
Typical Components of
Current Liabilities
• Notes payable
• Accounts payable
• Accrued expenses
• Advance deposits
• Income taxes payable
• Deferred income taxes
• Amounts due to owner, management
company, or related party
• Current maturities of long-term debt
Slide 16
Noncurrent Receivables

• Noncurrent Receivables includes both

accounts and notes receivable that are not
expected to be collected within one year from
the balance sheet date.
• If any collectibility is uncertain regarding
noncurrent receivables, an allowance for
doubtful noncurrent receivables should be
used.
• The allowance for doubtful noncurrent
receivables is subtracted from total
noncurrent receivables to provide net
noncurrent receivables.
Slide 17
 Investments
• Investments generally includes debt or equity
securities and ownership interests that are
expected to be held on a long-term basis.
• Investments in marketable equity securities and
debt securities are treated differently based on
whether there is the intent and ability to hold
such securities to maturity or not.
• Investments in affiliated entities should be
shown separately, unless insignificant.
• Investments in property for future development
generally should also be accounted for as
investments.
• The accounting method and valuation basis
should be disclosed inSlide
notes18 to the financial
Property and Equipment
• Property and Equipment consists of fixed
assets including land, buildings,
furnishings and equipment, construction in
progress, and leasehold improvements as
well as property and equipment under
capital leases.
• With the exception of land, the cost of all
property and equipment is written off to
expense (depreciation) over time in
accordance with the matching principle.
• Depreciation methods used should be
disclosed in a footnote to the balance
Slide 19
Other Assets
Other Assets consists of all noncurrent
assets not included in previous categories.
Other assets include:
• Intangible assets
• Cash surrender value of life insurance
• Deferred charges
• Deferred income taxes—noncurrent
• Operating equipment
• Restricted cash

Slide 20
Long-Term Liabilities
• Long-term liabilities are obligations at the
balance sheet date that are expected to
be paid beyond the next 12 months.
• Common long-term liabilities include notes
payable, mortgages payable, bonds
payable, capitalized lease obligations, and
deferred income taxes.
• Any long-term debt to be paid with current
assets within the next year is reclassified
as current liabilities.
Slide 21
Owners’ Equity

The detail of the owners’ equity section

depends on the operation’s business
form.
• For a corporation, this section includes
capital stock (common and, when
issued, preferred), additional paid-in
capital, retained earnings, and treasury
stock.
• For a sole proprietorship, partnership,
or LLC, equity is listed by owner,
Slide 22
Footnotes
• The full disclosure principle requires that
financial information be sufficient to inform
creditors, owners, and other users.
• This can only be accomplished by providing
footnotes to the financial statements.
• Footnotes should contain information not
presented in the financial statements that
provides contextual information needed to
interpret those statements.
• Footnotes should not contradict or soften the
disclosure of the financial statements, but
rather provide needed explanations.
Slide 23
Balance Sheet Analysis

The analysis of a balance sheet may

include the following:
• Horizontal analysis (comparative
statements)
• Vertical analysis (common-size
statements)
• Base-year comparisons
• Ratio analysis
Slide 24
Horizontal Analysis
• Horizontal analysis compares two balance
sheets—the current balance sheet and the
balance sheet of the previous period.
• The two balance sheets are often referred to
as comparative balance sheets.
• Horizontal analysis is the simplest approach
to analysis and is essential to fairly reporting
financial information.
• This approach often expresses the changes
from one period to the next in both absolute
and relative terms.
Slide 25
Vertical Analysis
• Vertical analysis, also known as common-size
statement analysis, reduces figures to
percentages.
• Individual asset are stated as percentages of total
assets. Liability and equity accounts are
expressed as percentages of total liabilities and
owners’ equity.
• Common-size balance sheets permit a
comparison of amounts relative to a base within
each period.
• Common-size statement comparisons may also
be made against other operations’ financial
statements and against
Slideindustry
26 averages.
Base-Year Comparisons

• Another approach to analyzing balance

sheets is base-year comparisons.
• This approach allows a meaningful
comparison of the balance sheets for
several periods.
• A base period is selected as a starting
point, and all subsequent periods are
compared with the base.
• Base-year comparisons make it easy to
quickly determine the changes over a
period of time. Slide 27