The balance sheet in a company's financial package is, in brief, a summary of everything the firm owns and the total of what they owe. The difference is Owner's Equity, and shareholders are very interested in the trend of this account. The value of assets is determined by evaluating the book value and the market value. Read this chapter to learn more, and pay particular attention to the market value vs. book value section.
The three limitations to balance sheets are assets being recorded at historical cost, use of estimates, and the omission of valuable non-monetary assets.
Critique the balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, business partnership, corporation, or other business organization, such as an LLC or an LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a "snapshot of a company's financial condition". Of the four basic financial statements, the balance sheet is the only statement which applies to a single point in time of a business' calendar year. There are three primary limitations to balance sheets, including the fact that they are recorded at historical cost, the use of estimates, and the omission of valuable things, such as intelligence.
Fixed assets are shown in the balance sheet at historical cost less
depreciation up to date. Depreciation affects the carrying value of an
asset on the balance sheet. The historical cost will equal the carrying
value only if there has been no change recorded in the value of the
asset since acquisition. Therefore, the balance sheet does not show true
value of assets. Historical cost is criticized for its inaccuracy since
it may not reflect current market valuation.
Four depreciation methods: Different methods of depreciation affect the carrying value of an asset on balance sheets.
Some of the current assets are valued on estimated basis, so the balance sheet is not in a position to reflect the true financial position of the business. Intangible assets like goodwill are shown in the balance sheet at imaginary figures, which may bear no relationship to the market value. The International Accounting Standards Board (IASB) offers some guidance (IAS 38) as to how intangible assets should be accounted for in financial statements. In general, legal intangibles that are developed internally are not recognized, and legal intangibles that are purchased from third parties are recognized. Therefore, there is a disconnect–goodwill from acquisitions can be booked, since it is derived from a market or purchase valuation. However, similar internal spending cannot be booked, although it will be recognized by investors who compare a company's market value with its book value.
Finally, the balance sheet can not reflect those assets which cannot be expressed in monetary terms, such as skill, intelligence, honesty, and loyalty of workers.