Page 174 - Accounting Principles (A Business Perspective)

4. Completing the accounting cycle

Long-term liabilities are debts such as a mortgage payable and bonds payable that are not due for more than
one year. Companies should show maturity dates in the balance sheet for all long-term liabilities. Normally, the
liabilities with the earliest due dates are listed first.

Notes payable with maturity dates at least one year beyond the balance sheet date are long-term liabilities.
Bonds payable are long-term liabilities and are evidenced by formal printed certificates sometimes secured by
liens (claims) on property, such as mortgages. Maturity dates should appear on the balance sheet for all major long-
term liabilities.
The deferred income taxes on The Home Depot's balance sheet result from a difference between income tax
expense in the accounting records and the income tax payable on the company's tax return.
Stockholders' equity shows the owners' interest in the business. This interest is equal to the amount

contributed plus the income left in the business.
The items under stockholders' equity in The Home Depot's balance sheet are paid-in capital (including common
stock) and retained earnings. Paid-in capital shows the capital paid into the company as the owners' investment.
Retained earnings shows the cumulative income of the company less the amounts distributed to the owners in
the form of dividends. Cumulative translation adjustments result from translating foreign currencies into US
dollars (a topic discussed in advanced accounting courses). The unrealized loss on investments is discussed in
Chapter 14.
The next section shows how two categories on the classified balance sheet relate to each other. Together they
help reveal a company's short-term debt-paying ability.

Analyzing and using the financial results — the current ratio

The current ratio indicates the short-term debt-paying ability of a company. To find the current ratio, we
divide current assets by current liabilities. For instance, Exhibit 26 shows that The Home Depot's current assets as
of 2001 January 28, were USD 7,777,000,000 and its current liabilities were USD 4,385,000,000. Thus, its current
Current assets USD7,777,000,000
ratio was: Current ratio= =1.77:1
Current liabilities USD4,385,000,000
The current ratio of 1.77:1 for The Home Depot means that it has almost twice as many current assets as current
liabilities. Because current liabilities are normally paid with current assets, the company appears to be able to pay
its short-term obligations easily.
In evaluating a company's short-term debt-paying ability, you should also examine the quality of the current
assets. If they include large amounts of uncollectable accounts receivable and/or obsolete and unsalable inventory,
even a 2:1 current ratio may be inadequate to allow the company to pay its current liabilities. The Home Depot
undoubtedly does not have such a problem.
The current assets, current liabilities, and current ratios of some other companies as of the third quarter of 2001
were:

Current Current Current Ratio
Company Assets Liabilities
Wal-Mart Stores, Inc. $ 32,620,000,000 $ 32,869,000,000 .99:1
Hewlett-Packard Company 15,782,000,000 13,950,000,000 1.13:1
3M Corporation 6,556,000,000 5,006,000,000 1.31:1
General Electric Company 313,050,000,000 168,788,000,000 1.85:1
Johnson & Johnson 19,079,000,000 7,504,000,000 2.54:1
We described each of these companies earlier in the text.

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