AccountingCoach.com Financial Ratios

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2 AccountingCoach.com Financial Ratios All underlined words are defined in the attached Glossary (Pages 13 20). Introduction to Financial Ratios When analyzing computing financial ratios and when doing other financial statement analysis always keep in mind that the financial statements reflect the accounting principles. This means assets are generally not reported at their current value. It is also likely that many brand names and unique product lines will not be included among the assets reported on the balance sheet, even though they may be the most valuable of all the items owned by a company. These examples are signals that financial ratios and financial statement analysis have limitations. It is also important to realize that an impressive financial ratio in one industry might be viewed as less than impressive in a different industry. Our explanation of financial ratios and financial statement analysis is organized as follows: 1. Balance Sheet a. General discussion b. Common-size balance sheet c. Financial ratios based on the balance sheet 2. Income Statement a. General discussion b. Common-size income statement c. Financial ratios based on the income statement 3. Statement of Cash Flows 1a. General Discussion of Balance Sheet The balance sheet reports a company's assets, liabilities, and stockholders' equity as of a specific date, such as December 31, 2005, September 28, 2006, etc. Copyright AccountingCoach.com. 1

3 The accountants' cost principle and the monetary unit assumption will limit the assets reported on the balance sheet. Assets will be reported (1) only if they were acquired in a transaction, and (2) generally at an amount that is not greater than the asset's cost at the time of the transaction. This means that a company's creative and effective management team will not be listed as an asset. Similarly, a company's outstanding reputation, its unique product lines, and brand names developed within the company will not be reported on the balance sheet. As you may surmise, these items are often the most valuable of all the things owned by the company. (Brand names purchased from another company will be recorded in the company's accounting records at their cost.) The accountants' matching principle will result in assets such buildings, equipment, furnishings, fixtures, vehicles, etc. being reported at amounts less than cost. The reason is these assets are depreciated. Depreciation reduces an asset's book value each year and the amount of the reduction is reported as Depreciation Expense on the income statement. While depreciation is reducing the book value of certain assets over their useful lives, the current value (or fair market value) of these assets may actually be increasing. (It is also possible that the current value of some assets such as computers may be decreasing faster than the book value.) Current assets such as Cash, Accounts Receivable, Inventory, Supplies, Prepaid Insurance, etc. usually have current values that are close to the amounts reported on the balance sheet. Current liabilities such as Notes Payable (due within one year), Accounts Payable, Wages Payable, Interest Payable, Unearned Revenues, etc. are also likely to have current values that are close to the amounts reported on the balance sheet. Long-term liabilities such as Notes Payable (not due within one year) or Bonds Payable (not maturing within one year) will often have current values that differ from the amounts reported on the balance sheet. Stockholders' equity is the book value of the company. It is the difference between the reported amount of assets and the reported amount of liabilities. For the reasons mentioned above, the reported amount of stockholders' equity will therefore be different from the current or market value of the company. By definition the current assets and current liabilities are "turning over" at least once per year. As a result, the reported amounts are likely to be similar to their current value. The long-term assets and long-term liabilities are not "turning over" often. Therefore, the amounts reported for long-term assets and long-term liabilities will likely be different Copyright AccountingCoach.com. 2

4 from the current value of those items. The remainder of our explanation of financial ratios and financial statement analysis will use information from the following balance sheet: ASSETS Current Assets Example Company Balance Sheet December 31, 2005 LIABILITIES Current Liabilities Cash $ 2,100 Notes Payable $ 5,000 Petty Cash 100 Accounts Payable 35,900 Temporary Investments 10,000 Wages Payable 8,500 Accounts Receivable - net 40,500 Interest Payable 2,900 Inventory 31,000 Taxes Payable 6,100 Supplies 3,800 Warranty Liability 1,100 Prepaid Insurance 1,500 Unearned Revenues 1,500 Total Current Assets 89,000 Total Current Liabilities 61,000 Investments 36,000 Long-term Liabilities Notes Payable 20,000 Property, Plant & Equipment Bonds Payable 400,000 Land 5,500 Total Long-term Liabilities 420,000 Land Improvements 6,500 Buildings 180,000 Equipment 201,000 Total Liabilities 481,000 Less: Accum Depreciation (56,000) Prop, Plant & Equip - net 337,000 Intangible Assets STOCKHOLDERS' EQUITY Goodwill 105,000 Common Stock 110,000 Trade Names 200,000 Retained Earnings 229,000 Total Intangible Assets 305,000 Less: Treasury Stock (50,000) Other Assets 3,000 Total Stockholders' Equity 289,000 Total Assets $770,000 Total Liabilities & Stockholders' Equity $770, Copyright AccountingCoach.com. 3

5 1b. Common-Size Balance Sheet One technique in financial statement analysis is known as vertical analysis. Vertical analysis results in common-size financial statements. A common-size balance sheet is a balance sheet where every dollar amount has been restated to be a percentage of total assets. We will illustrate this by taking Example Company's balance sheet (shown above) and divide each item by the total asset amount $770,000. The result is the following common-size balance sheet for Example Company: Copyright AccountingCoach.com. 4

6 ASSETS Current Assets Example Company Balance Sheet December 31, 2005 LIABILITIES Current Liabilities Cash 0.3% Notes Payable 0.6% Petty Cash 0.0% Accounts Payable 4.7% Temporary Investments 1.3% Wages Payable 1.1% Accounts Receivable - net 5.3% Interest Payable 0.4% Inventory 4.0% Taxes Payable 0.8% Supplies 0.5% Warranty Liability 0.1% Prepaid Insurance 0.2% Unearned Revenues 0.2% Total Current Assets 11.6% Total Current Liabilities 7.9% Investments 4.7% Long-term Liabilities Notes Payable 2.6% Property, Plant & Equipment Bonds Payable 52.0% Land 0.7% Total Long-term Liabilities 54.6% Land Improvements 0.8% Buildings 23.4% Equipment 26.1% Total Liabilities 62.5% Less: Accum Depreciation (7.3%) Prop, Plant & Equip - net 43.7% Intangible Assets STOCKHOLDERS' EQUITY Goodwill 13.6% Common Stock 14.3% Trade Names 26.0% Retained Earnings 29.7% Total Intangible Assets 39.6% Less: Treasury Stock (6.5%) Other Assets 0.4% Total Stockholders' Equity 37.5% Total Assets 100.0% Total Liabilities & Stockholders' Equity 100.0% Copyright AccountingCoach.com. 5

7 The benefit of a common-size balance sheet is that an item can be compared to a similar item of another company regardless of the size of the companies. A company can also compare its percentages to the industry's average percentages. For example, a company with Inventory at 4.0% of total assets can look to its industry statistics to see if its percentage is reasonable. (Industry percentages might be available from an industry association, library reference desks, and from bankers. Generally banks have memberships in Robert Morris Associates, an organization that collects and distributes statistics by industry.) A common-size balance sheet also allows two businesspersons to compare the magnitude of a balance sheet item without either one revealing the actual dollar amounts. 1c. Financial Ratios Based on the Balance Sheet Financial statement analysis includes financial ratios. Here are three financial ratios that are based solely on current asset and current liability amounts appearing on a company's balance sheet: Financial Ratio How to Calculate It What It Tells You Working Capital Current Ratio Current Assets Current Liabilities $89,000 $61,000 $28,000 Current Assets Current Liabilities $89,000 $61, An indicator of whether the company will be able to meet its current obligations (pay its bills, meet its payroll, make a loan payment, etc.) If a company has current assets exactly equal to current liabilities, it has no working capital. The greater the amount of working capital the more likely it will be able to make its payments on time. This tells you the relationship of current assets to current liabilities. A ratio of 3:1 is better than 2:1. A 1:1 ratio means there is no working capital. Copyright AccountingCoach.com. 6

8 Quick Ratio (Acid Test Ratio) [(Cash + Temp. Investments + Accounts Receivable) Current Liabilities] : 1 [($2,100 + $100 + $10,000 + $40,500) $61,000] : 1 [$52,700 $61,000] : 1 This ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded. This indicates the relationship between the amount of assets that can quickly be turned into cash versus the amount of current liabilities : 1 Four financial ratios relate balance sheet amounts for Accounts Receivable and Inventory to income statement amounts. To illustrate these financial ratios we will use the following income statement information: Example Corporation Income Statement For the year ended December 31, 2005 Sales (all on credit) $500,000 Cost of Goods Sold 380,000 Gross Profit 120,000 Operating Expenses Selling Expenses 35,000 Administrative Expenses 45,000 Total Operating Expenses 80,000 Operating Income 40,000 Interest Expense 12,000 Income before Taxes 28,000 Income Tax Expense 5,000 Net Income after Taxes $ 23,000 Copyright AccountingCoach.com. 7

9 Financial Ratio How to Calculate It What It Tells You Accounts Receivable Turnover Net Credit Sales for the Year Average Accounts Receivable for the Year $500,000 $42,000 (a computed average) The number of times per year that the accounts receivables turn over. Keep in mind that the result is an average, since credit sales and accounts receivable are likely to fluctuate during the year. It is important to use the average balance of accounts receivable during the year. Days' Sales in Accounts Receivable 365 days in Year Accounts Receivable Turnover in Year 365 days days The average number of days that it took to collect the average amount of accounts receivable during the year. This statistic is only as good as the Accounts Receivable Turnover figure. Inventory Turnover Cost of Goods Sold for the Year Average Inventory for the Year $380,000 $30,000 (a computed average) The number of times per year that Inventory turns over. Keep in mind that the result is an average, since sales and inventory levels are likely to fluctuate during the year. Since inventory is at cost (not sales value), it is important to use the Cost of Goods Sold. Also be sure to use the average balance of inventory during the year. Days' Sales in Inventory 365 days in Year Inventory Turnover in Year 365 days The average number of days that it took to sell the average inventory during the year. This statistic is only as good as the Inventory Turnover figure. Copyright AccountingCoach.com. 8

10 The next financial ratio involves the relationship between two amounts from the balance sheet: total liabilities and total stockholders' equity: Financial Ratio How to Calculate It What It Tells You Debt to Equity (Total liabilities Total Stockholders' Equity) : 1 ( $481,000 $289,000) : : 1 The proportion of a company's assets supplied by the company's creditors versus the amount supplied the owner or stockholders. In this example the creditors have supplied $1.66 for each $1.00 supplied by the stockholders. 2a. General Discussion of Income Statement 2a. General Discussion of Income Statement The income statement has some limitations since it reflects accounting principles. For example, a company's depreciation expense is based on the cost of the assets it has acquired and is using in its business. The resulting depreciation expense may not be a good indicator of the economic value of the asset being used up. To illustrate this point let's assume that a company's buildings and equipment have been fully depreciated and therefore there will be no depreciation expense for those buildings and equipment on its income statement. Is zero expense a good indicator of the cost of using those buildings and equipment? Compare that situation to a company with new buildings and equipment where there will be large amounts of depreciation expense. The remainder of our explanation of financial ratios and financial statement analysis will use information from the following income statement: Copyright AccountingCoach.com. 9

11 Example Corporation Income Statement For the year ended December 31, 2005 Sales (all on credit) $500,000 Cost of Goods Sold 380,000 Gross Profit 120,000 Operating Expenses Selling Expenses 35,000 Administrative Expenses 45,000 Total Operating Expenses 80,000 Operating Income 40,000 Interest Expense 12,000 Income before Taxes 28,000 Income Tax Expense 5,000 Net Income after Taxes $ 23,000 Earnings per Share (based on 100,000 shares outstanding) $ b. Common-Size Income Statement Financial statement analysis includes a technique known as vertical analysis. Vertical analysis results in common-size financial statements. A common-size income statement presents all of the income statement amounts as a percentage of net sales. Below is Example Corporation's common-size income statement after each item from the income statement above was divided by the net sales of $500,000: Copyright AccountingCoach.com. 10

12 Example Corporation Income Statement For the year ended December 31, 2005 Sales (all on credit) 100.0% Cost of Goods Sold 76.0% Gross Profit 24.0% Operating Expenses Selling Expenses 7.0% Administrative Expenses 9.0% Total Operating Expenses 16.0% Operating Income 8.0% Interest Expense 2.4% Income before Taxes 5.6% Income Tax Expense 1.0% Net Income after Taxes 4.6% The percentages shown for Example Corporation can be compared to other companies and to the industry averages. Industry averages can be obtained from trade associations, bankers, and library reference desks. If a company competes with a company whose stock is publicly traded, another source of information is that company's "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in its annual report to stockholders. Generally the annual report as well as reports to the Securities and Exchange Commission are available on the company's website. Copyright AccountingCoach.com. 11

13 2c. Financial Ratios Based on the Income Statement Financial Ratio How to Calculate It What It Tells You Gross Margin Profit Margin (after tax) Gross Profit Net Sales $120,000 $500, % Net Income after Tax Net Sales $23,000 $500, % Indicates the percentage of sales dollars available for expenses and profit after the cost of merchandise is deducted from sales. The gross margin varies between industries and often varies between companies within the same industry. Tells you the profit per sales dollar after all expenses are deducted form sales. This margin will vary between industries as well as between companies in the same industry. Earnings Per Share (EPS) Net Income after Tax Weighted Average Number of Common Shares Outstanding $23, ,000 $0.23 Expresses the corporation's net income after taxes on a per share of common stock basis. The computation requires the deduction of preferred dividends from the net income if a corporation has preferred stock. Also requires the weighted average number of shares of common stock during the period of the net income. Times Interest Earned Earnings for the Year before Interest and Income Tax Expense Interest Expense for the Year $40,000 $12,000 Indicates a company's ability to meet the interest payments on its debt. In the example the company is earning 3.3 times the amount it is required to pay its lenders for interest. 3.3 Return on Stockholders' Equity (after tax) Net Income for the Year after Taxes Average Stockholders' Equity during the Year $23,000 $278,000 (a computed average) 8.3% Reveals the percentage of profit after income taxes that the corporation earned on its average common stockholders' balances during the year. If a corporation has preferred stock, the preferred dividends must be deducted from the net income. Copyright AccountingCoach.com. 12

14 Conclusion Because the material covered here is considered an introduction to the topic of financial ratios, there are many complexities not presented. You should always consult with an accounting professional for assistance with your own specific circumstances. Glossary accounting principles The standards, rules, guidelines, and industry-specific requirements for financial reporting. To learn more, see Explanation of Accounting Principles. accounts payable This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest payable, etc.) accounts receivable A current asset resulting from selling goods or services on credit (on account). Invoice terms such as (a) net 30 days or (b) 2/10, n/30 signify that a sale was made on account and was not a cash sale. accounts receivable - net The combined amount of the debit balance in the current asset account Accounts Receivable and the credit balance in the contra asset account Allowance for Doubtful Accounts. The difference between the balances in these two accounts is an approximation of the amount of the accounts receivable that is likely to turn to cash (be collected). accumulated depreciation The amount of a long term asset's cost that has been allocated to Depreciation Expense since the time that the asset was acquired. Accumulated Depreciation is a long-term contra asset account (an asset account with a credit balance) that is reported on the balance sheet under the heading Property, Plant, and Equipment. admininstrative expenses Administrative expenses are part of the operating expenses (along with selling expenses). Administrative expenses include expenses associated with the general administration of the business. Examples include the salaries and fringe benefits of the company president, human resource personnel, accounting, Copyright AccountingCoach.com. 13

15 information technology, the depreciation expense for equipment and space used in administration, as well as supplies, utilities, etc. Under the accrual basis of accounting, administrative expenses appear on the income statement for the period in which they occurred (not the period in which they were paid). assets Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles. Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation: Assets Liabilities + Owner's (Stockholders') Equity. Some valuable items that cannot be measured and expressed in dollars include the company's outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet. balance sheet One of the main financial statements. The balance sheet reports the assets, liabilities, and owner's (stockholders') equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Position. To learn more, see Explanation of Balance Sheet. bonds payable Generally a long term liability account containing the face amount, par amount, or maturity amount of the bonds issued by a company that are outstanding as of the balance sheet date. book value The book value of an asset is the amount of cost in its asset account less the accumulated depreciation applicable to the asset. The book value of a company is the amount of owner's or stockholders' equity. book value of a company The amount of owner's equity or stockholders' equity reported on a company's balance sheet. This is not an indication of the company's fair market value. Copyright AccountingCoach.com. 14

16 buildings Buildings is a noncurrent or long-term asset account which shows the cost of a building (excluding the cost of the land). Buildings will be depreciated over their useful lives by debiting the income statement account Depreciation Expense and crediting the balance sheet account Accumulated Depreciation. capital expenditures Amounts spent for property, plant and equipment. cash A current asset account which includes currency, coins, checking accounts, and undeposited checks received from customers. The amounts must be unrestricted. (Restricted cash should be recorded in a different account.) common stock The type of stock that is present at every corporation. (Some corporations have preferred stock in addition to their common stock.) Shares of common stock is evidence of ownership in a corporation. Holders of common stock elect the corporation's directors and share in distribution of profits of the company via dividends after preferred stock (if any) receives its dividend. If the corporation were to liquidate, the secured lenders would be paid first, followed by unsecured lenders, then the preferred stockholders, and lastly the common stockholders. cost of goods sold Cost of Goods Sold is usually the largest expense on the income statement of a company selling products or goods. This account or this calculation (depends on inventory system) matches the cost of the goods sold with the sales (revenue) of the goods that have been sold. The Cost of Goods Sold can be computed as follows: cost of beginning inventory + cost of goods purchased (net of any returns or allowances) + freight-in - cost of ending inventory. cost principle The accounting guideline requiring amounts in the accounts and on the financial statements to be the actual cost rather than the current value. Accountants can show an amount less than cost due to conservatism, but accountants are generally prohibited from showing amounts greater than cost. (Certain investments will be shown at fair value instead of cost.) current assets Cash and other resources that are expected to turn to cash or to be used up within one year of the balance sheet date. (If a company's operating cycle is longer than one year, an item is a current asset if it will turn to cash or be used up within the operating cycle.) Current assets are presented in the order of Copyright AccountingCoach.com. 15

17 liquidity, i.e., cash, temporary investments, accounts receivable, inventory, supplies, prepaid insurance. current liabilities Obligations due within one year of the balance sheet date. (If a company's operating cycle is longer than one year, an item is a current liability if it is due within the operating cycle.) Another condition is that the item will use cash or it will create another current liability. (This means that if a bond payable is due within one year of the balance sheet date, but the bond will be retired by a bond sinking fund (a long term restricted asset) the bond will not be reported as a current liability.) current value The present fair market value. depreciated An asset's cost that has been assigned to Depreciation Expense. depreciation expense The income statement account which contains a portion of the cost of plant and equipment that is being matched to the time interval shown in the heading of the income statement. (There is no depreciation expense for land.) goodwill Goodwill is a long-term asset categorized as an intangible asset. Goodwill arises when a company acquires another entire business. The amount of goodwill is the cost to purchase the business minus the fair market value of the tangible assets, the intangible assets that can be identified, and the liabilities obtained in the purchase. The amount in the Goodwill account will be adjusted to a smaller amount if there is an impairment in the value of the acquired company as of a balance sheet date. gross profit Net sales revenues minus the cost of goods sold. income statement One of the main financial statements (along with the balance sheet, the statement of cash flows, and the statement of stockholders' equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in the heading of the statement. If a company's stock is publicly traded, earnings per share must appear on the face of the income statement. To learn more, see Explanation of Income Statement. Copyright AccountingCoach.com. 16

18 interest expense This account is a non-operating or "other" expense for the cost of borrowed money or other credit. The amount of interest expense appearing on the income statement is the cost of the money that was used during the time interval shown in the heading of the income statement, not the amount of interest paid during that period of time. interest payable This current liability account reports the amount of interest the company owes as of the date of the balance sheet. (Future interest is not recorded as a liability.) income tax expense The amount of income tax that is associated with (matches) the net income reported on the company's income statement. This amount will likely be different than the income taxes actually payable, since some of the revenues and expenses reported on the tax return will be different from the amounts on the income statement. For example, a corporation is likely to use straight line depreciation on its income statement, but will use accelerated depreciation on its income tax return. inventory A current asset whose ending balance should report the cost of a merchandiser's products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, work in process, and finished goods. The cost of inventory should include all costs necessary to acquire the items and to get them ready for sale. When inventory items are acquired or produced at varying costs, the company will need to make an assumption on how to flow the changing costs. See cost flow assumptions. If the cost to replace inventory is less than the actual cost of the inventory, it may be necessary to reduce the inventory amount. See lower of cost or market. To learn more, see Explanation of Inventory & Cost of Goods Sold. land A long-term asset account that reports the cost of real property exclusive of the cost of any constructed assets on the property. Land usually appears as the first item under the balance sheet heading of Property, Plant and Equipment. Generally, land is not depreciated. Copyright AccountingCoach.com. 17

19 land improvements A long-term asset which indicates the cost of the constructed improvements to land, such as driveways, walkways, lighting, and parking lots. Land Improvements will be depreciated over their useful life by debiting the income statement account Depreciation Expense and by crediting the balance sheet account Accumulated Depreciation. long term liabilities 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. matching principle The principle that requires a company to match expenses with related revenues in order to report a company's profitability during a specified time interval. Ideally, the matching is based on a cause and effect relationship: sales causes the cost of goods sold expense and the sales commissions expense. If no cause and effect relationship exists, accountants will show an expense in the accounting period when a cost is used up or has expired. Lastly, if a cost cannot be linked to revenues or to an accounting period, the expense will be recorded immediately. An example of this is Advertising Expense and Research and Development Expense. monetary unit assumption An accounting guideline where the U.S. dollar is assumed to be constant (no change in purchasing power) over time. This allows an accountant to add one dollar from a transaction in 1946 to one dollar in 2004 and to show the result as two dollars. It also means that items that cannot be expressed in dollars do not appear in the financial statements. For example, how would you express on a company's balance sheet the value of loyal customers or a brilliant, aggressive management team? notes payable The amount of principal due on a formal written promise to pay. Loans from banks are included in this account. petty cash A current asset account that represents an amount of cash for making small disbursements such as postage due and reimbursements for small amounts of supplies. prepaid insurance A current asset which indicates the cost of the insurance contract (premiums) that have been paid in advance. It represents the amount that has been paid but has not yet expired as of the balance sheet date. Copyright AccountingCoach.com. 18

20 A related account is Insurance Expense, which appears on the income statement. The amount in the Insurance Expense account should report the amount of insurance expense expiring during the period indicated in the heading of the income statement. retained earnings A stockholders' equity account that 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. selling expenses Selling expenses are part of the operating expenses (along with administrative expenses). Selling expenses include sales commissions, advertising, promotional materials distributed, rent of the sales showroom, rent of the sales offices, salaries and fringe benefits of sales personnel, utilities and telephone usage in the sales department, etc. Under the accrual basis of accounting, selling expenses appear on the income statement in the period in which they occurred (not the period in which they were paid). statement of cash flows One of the main financial statements (along with the income statement and balance sheet). The statement of cash flows reports the sources and uses of cash by operating activities, investing activities, financing activities, and certain supplemental information for the period specified in the heading of the statement. To learn more, see Explanation of Cash Flow Statement. stockholders' equity Also referred to as shareholders' equity. At a corporation it is the residual or difference of assets minus liabilities. supplies A current asset representing the cost of supplies on hand at a point in time. The account is usually listed on the balance sheet after the Inventory account. A related account is Supplies Expense, which appears on the income statement. The amount in the Supplies Expense account reports the amounts of supplies that were used during the time interval indicated in the heading of the income statement. taxes payable A liability account that reports the amount of taxes that a company owes as of the balance sheet date. Copyright AccountingCoach.com. 19

21 temporary investments A current asset account which contains the amount of investments that can and will be sold in the near future. trade names An intangible asset reported on the balance sheet at the company's cost (or lower). Often, successful trade names were developed by companies over many years. As a result the cost of the trade name is minimal, but the trade names are often the most valuable assets of the company. Trade names should be registered with the U. S. Patent and Trademark Office. treasury stock A corporation's own stock that has been repurchased from stockholders. Also a stockholders' equity account that usually reports the cost of the stock that has been repurchased. unearned revenue(s) A liability account that reports amounts received in advance of providing goods or services. When the goods or services are provided, this account balance is decreased and a revenue account is increased. To learn more, see Explanation of Adjusting Entries for a further discussion. useful life This is the period of time that it will be economically feasible to use an asset. Useful life is used in computing depreciation on an asset, instead of using the physical life. For example, a computer might physically last for 100 years; however, the computer might be useful for only three years due to technology enhancements that are occurring. As a consequence, for financial statement purposes the computer will be depreciated over three years. wages payable A current liability account that reports the amounts owed to emplyees for hours worked but not yet paid as of the date of the balance sheet. warranty liability A liability account that reports the estimated amount that a company will have to spend to repair or replace a product during its warranty period. The liability amount is recorded at the time of the sale. (It is also the time when the expense is reported.) The liability will be reduced by the actual expenditures to repair or replace the product. Warranty Payable or Warranty Liability is considered to be a contingent liability that is both probable and capable of being estimated. Copyright AccountingCoach.com. 20