The Balance Sheet Referencing this week?s readings and lecture, what information is provided in the balance sheet? What is a common-sized balance sheet and how do you create one? For your final project company, does anything stand out on the balance sheet? Respond to at least two of your classmates? posts. Understanding the Notes to the Balance Sheet Your friend, Liz, loves to shop at Target and is now interested in investing in the company. Tom, another friend, has told her that Target?s debt structure is risky with obligations of nearly 74% of total assets. Liz sees that debt on the balance sheet is 65% of total assets and is confused by Tom?s comment. Write an explanation to Liz discussing the debt structure of Target and why Tom thinks Target is risky. Be sure to explain clearly what information appears on financial statements, as well as what information does not appear directly on the financial statements. Use the information below in your discussion. At fiscal year-end February 2, 2008, Target Corporation had the following assets and liabilities on its balance sheet (in millions): Current liabilities $11,782 Long-term debt 15,126 Other liabilities 2,345 Total assets 44,560 Target reported the following information on leases in the notes to the financial statements: Total rent expense was $165 million in 2007, $158 million in 2006, and $154 million in 2005, including percentage rent expense of $5 million in 2007, 2006, and 2005. Most long-term leases include one or more options to renew, with renewal terms that can extend the lease term to more than 50 years. Certain leases also include options to purchase the leased property. Future minimum lease payments required under non-cancellable lease agreements existing at February 2, 2008, were: Future Minimum Lease Payments (in Millions) Operating Leases Capital Leases 2008 $ 239 $ 12 2009 187 16 2010 173 16 2011 129 16 2010 123 17 After 2010 2, 843 155 Total future minimum lease payments $3694 (a) $232 Less: Interest (b) (105) Present value of minimum capital lease payments $127 (c) a) Total contractual lease payments include $1,721 million related to options to extend lease terms that are reasonably assured of being exercised, and also include $98 million of legally binding minimum lease payments for stores that will open in 2008 or later. (b) Calculated using the interest rate at inception of each lease. (c) Includes current portion of $4 million.

2 The Balance Sheet Yong Hian Lim/iStock/Thinkstock Learning Objectives After reading this chapter, you should be able to: 1. Describe the elements of a balance sheet. 2. Describe the different types of accounts contained in the balance sheet among assets, liabilities, and shareholders' equity. 3. Explore the different methods of accounting for inventory (LIFO and FIFO) and the effects on the value of the inventory. 4. Explain how to create a common-sized balance sheet. eps81356_02_c02_045-096.indd 45 3/25/14 3:11 PM Introduction Pre-Test 1. What is the purpose of a balance sheet? a. to show that the books are in balance b. to give a snapshot of a company's financial position on a given date c. to show what the company owns d. to show what the company owes 2. Which is the basic formula for a balance sheet? a. Assets minus Liabilities equal Equity b. Assets equal Liabilities plus Equity c. Net Assets equal Net Profit d. none of the above 3. What is the bottom line of the balance sheet shown in account format? a. Total Assets b. Total Liabilities and Equity c. Total Liabilities d. both A and B 4. What are inventory valuation methods? a. LIFO and FIDO b. LIFO and FIFO c. Average Cost d. both B and C 5. What is a tool used to compare balance sheets among various companies, large and small? a. average balance sheets b. common-sized balance sheets c. industry balance sheets d. no tool available Answers can be found at the end of the chapter. Introduction In Chapter 1, we introduced the members of Best General Company's budget committee. In this chapter, the budget committee begins its analysis of the company's results by taking a closer look at the balance sheet. To introduce the balance sheet, we have created a basic one for Best General Company (shown in Figure 2.1). It uses numbers that are much simpler than the ones that show up on the balance sheets of major corporations. Later in the chapter we will explore the complex balance sheets of two real-world corporations: IBM and 3M. eps81356_02_c02_045-096.indd 46 3/25/14 3:11 PM Introduction Figure 2.1: Sample balance sheet for Best General Company The balance sheet provides a quick snapshot into the overall financial health of an organization as of a particular date. Best General Company Balance Sheet At December 31, 2013 and 2012 2013 2012 Assets Current Assets: Cash Accounts Receivable Inventories Other Current Assets Total Current Assets Long-Term Assets: Property, Plant, & Equipment Less: Accumulated Depreciation Other Non-Current Assets Total Assets Liabilities Current Liabilities: Accounts Payable Short-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Liabilities: Long-Term Debt Other Non-Current Liabilities Total Liabilities Shareholders' Equity Common Stock Retained Earnings Total Shareholders' Equity Total Liabilities and Shareholders' Equity eps81356_02_c02_045-096.indd 47 $ $ $ 8,400 7,800 40,000 6,000 62,200 99,600 (9,600) 45,000 197,200 8,900 26,000 20,400 55,300 $ 62,450 52,000 169,750 $ $ 20,000 7,450 27,450 197,200 $ $ $ 9,500 7,200 38,000 6,000 60,700 99,600 (7,200) 45,000 198,100 9,400 26,000 19,800 55,200 $ 65,000 54,000 174,200 $ $ 20,000 3,900 23,900 198,100 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet First, notice in Figure 2.1 that the Total Assets equal the Total Liabilities and Equity. That must always be true on a balance sheet. If that is not the case, there is an error somewhere. We take a closer look at why this is so in this chapter. Also in Figure 2.1 we see that Accounts Receivable, which is where the accounts of customers who owe money to the company are tracked, is increasing in value. This could be a sign of trouble or it could mean that sales on credit increased from year to year. When Juan and Susan see this number, they know they will need to research it further to find out whether there is a problem collecting from customers. Another possible indicator of a problem is that Inventories are increasing in value. This could indicate that sales are slowing because inventory is sitting on the shelf and not sellingor it could mean the company has added to the variety of inventory carried. As the Best General budget committee develops its budget report, its members will want to take a closer at these numbers and determine why the value of inventory is increasing. They may need to recommend that the company plan for lower revenues or for new ways to increase its sales if it wants to keep revenue expectations at the same level or increase projected revenues for the next budget year. Let's take a closer look at the elements of a balance sheet. 2.1 The Elements of a Balance Sheet Consider a gymnast walking a balance beam: If she steps a bit to the right or left, she will fall off. She can only stay on the beam if she balances perfectly in the center. Just like that gymnast, a company's balance sheet (also known as the statement of financial position) must stay in balance on a very thin line. Any deviation can throw a company's books off balance. Balance is based on the key equation for all accounting: Assets 5 Liabilities 1 Equity This balancing act works because funds borrowed from lenders or cash raised from investors is used to fund the assets the company owns. The Liability section shows the funds borrowed from lenders and the Equity section shows money invested in the company by the investors (the owners of the company). The Equity section also shows the profits retained to reinvest in the company in an account called Retained Earnings. Every transaction entered into the accounting system must take this key formula into consideration. In Chapter 1, we introduced these three key elements: assets, liabilities, and equity. In this chapter, we'll explore how the numbers are developed for the balance sheet, as well as the key rules companies follow when preparing this statement. eps81356_02_c02_045-096.indd 48 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Some Notes on Entering Numbers Into the Accounting System Before exploring the balance sheet, let's discuss how the numbers are entered into the accounting system to be sure the balance sheet will be in balance. For example, when a company makes a cash purchase, it trades an asset, such as cash, for another asset, such as furniture. The outlay of cash is considered a credit and the intake of furniture is called a debit. This cash transaction would be entered in the accounts as shown in Table 2.1: Table 2.1: Accounting for cash transactions Date Accounts May 3 Debit Furniture Credit 1,000 Cash 1,000 In this entry, Assets are increased by $1,000 with the addition of furniture and decreased by $1,000 with the use of cash. So the balance sheet stays in balance. Suppose the company didn't pay cash for the item but instead used a credit card. This credit transaction would be entered into the books as shown in Table 2.2: Table 2.2: Accounting for credit card transactions Date Accounts May 3 Debit Furniture Credit 1,000 Credit Card Payable 1,000 In this entry, Assets are increased by $1,000 with the acquisition of furniture and Liabilities are increased by $1,000 with credit card debt. Again, the balance sheet stays in balance. In this text, we will not discuss how debits and credits work in detail; that is the subject of a basic accounting text. Rather, we will briefly explore the logistics that go into building the numbers for a balance sheet and their relationship to the key accounting formula: Assets 5 Liabilities 1 Equity If the transactions are not balanced when they enter the accounting system, the balance sheet will not be in balance. Note that debits and credits in accounting mean very different things than they do when looking at bank accounts or credit cards. A debit in a bank account always means that the number will be subtracted from the bank balance. A credit always means that the number will be added to the bank balance. eps81356_02_c02_045-096.indd 49 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet In accounting it is not that simple. Debits and credits can add to or subtract from the balance in an account depending on the type of account. For accounts that track assets and expenses, a debit will increase the value of that account and a credit will decrease the value. For accounts that track liabilities and income, a credit will increase the value of the account and a debit will decrease the value. The key to entering data into an accounting system is to ensure that the debits always equal the credits in a transaction entry in order to keep the books in balance. Table 2.3 summarizes how debits and credits impact a company's accounts: Table 2.3: How debits and credits impact accounts Account type Debit Credit Assets Increase Decrease Liabilities Decrease Increase Equity Decrease Increase Income Decrease Increase Expenses Increase Decrease Balance Sheet Presentation When preparing a balance sheet, several basic rules guide the dates for the statement, the numbers used, and the presentation format. We take a brief look at these key elements next. Task Box 2.1: Exploring Financial Statements: IBM and 3M As we explore the balance sheet and other financial statements in this and future chapters, we will occasionally use the financial statements of two companies, IBM and 3M, to find out how the numbers play out in the real world. We have chosen IBM because it is a service-based corporation that both develops technology solutions for its customers and sells the products for those solutions. This will provide a good overview of how both serviced-based and product-based corporations present their financial reports. IBM deemphasized manufacturing hardware beginning in 1994, and in 2012 focused its operations instead on services, software, and technology solutions, yet it still does some manufacturing. 3M also sells and manufactures its own products. It puts a greater focus on manufacturing and its financial statements reflect that difference. As we explore these financial statements, we will note some key differences presented in the financial reports for service, product, and manufacturing companies. Download the PDFs for the 2012 annual reports of IBM and 3M. Find the financial statements and the Notes to the Financial Statements in each. Be prepared to use them to complete this chapter and throughout other chapters. Note that both companies indicate they are \"Consolidated\" statements, meaning that the results include all subsidiaries. eps81356_02_c02_045-096.indd 50 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Dates of the Statement A balance sheet is like a snapshot of a company's financial position on a particular date. That is why the top of the balance sheet always includes the words \"as of\" or \"at\" and then a month, day, and year. A company's financial position changes daily as sales are made, inventory is bought or manufactured, and other transactions take place to keep the company operating. So when reviewing a balance sheet, keep in mind that it provides the company's financial position only for the date shown at the top. The date on the balance sheet will be the last date of the period being presented. This can be the end of a year, end of a quarter, end of a month, or end of another period, as designated by the company. The date on the balance sheet will be the same as the last day of operations shown on the income statement. (We'll explore the income statement in Chapter 3.) Note in the heading (top portion) of Best General's balance sheet shown in Figure 2.2 that the date of the statement is \"At December 31\" and the columns designate the two years shown (2013 and 2012). Figure 2.2: Top portion of the Best General Company balance sheet A great deal of information can be gleaned from the balance sheet. For example, from this partial sheet we can determine that Best General Company has less cash than in the previous period and accounts receivable and inventory amounts have increased. Best General Company Balance Sheet (Partial) At December 31, 2013 and 2012 2013 2012 Assets Current Assets: Cash Accounts Receivable Inventories Other Current Assets Total Current Assets $ $ 8,400 7,800 40,000 6,000 62,200 $ $ 9,500 7,200 38,000 6,000 60,700 Financial statements are not always presented on a calendar-year basis. Some companies report based on a different fiscal year. For example, many retail companies present their annual report starting on February 1 of any year until January 31 of the next year. They choose this 12-month period for two reasons: eps81356_02_c02_045-096.indd 51 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 1. They do not want to be preparing financial statements during their busiest time of year, the Christmas holiday season. For example, Walmart prepares its annual reports at the end of January. 2. January sales often include December returns and new sales, so the flow of their finances is more accurately reflected with a year-end of January rather than December. Another type of organization that does not usually report on a calendar-year basis is academic institutions. Such institutions are more likely to prepare statements based on their academic year. For example, the Apollo Group, which operates for-profit universities, reports annually at the end of August. Many non-profit learning institutions, which do not need to report to the SEC, do provide annual reports to their donors. These reports are usually based on a year-end of August 31. When comparing financial reports of various companies and institutions, always be sure to check the dates at the top of the reports. Be sure that the companies report using the same fiscal year in order to compare apples to apples. For example, suppose a manager wants to compare two retail companies. One company reports based on the calendar year ending December 31, 2012, and the second on a fiscal year ending January 31, 2013. The holiday season may affect these retailers very differently. If January was a big month in 2013, but sales were not as good in 2012, the two reports will not be easily comparable. Before the manager can conduct a financial comparison, he needs to find a quarterly report that gives month-by-month details of both companies and then adjust the financial reports of one these companies so the results represent the same time period. Another way some companies prepare their financial statements is to base the end of each financial period on a particular day of the week. (We talk about that scenario in \"World of Business.\") World of Business Another Twist to Financial Report Dating Most companies report on a calendar-year or fiscal-year basis that ends at the end of a month, but some companies prefer to report based on a particular day of the week. One such company is Darden, which operates popular restaurant chains such as Red Lobster, Olive Garden, and LongHorn Steakhouse. The company reports on the last Sunday of the month during each accounting period. Darden has determined that the best way to compare the results of its restaurants is to end each reporting period on the same day of the week because in the restaurant business, the volume of business differs by day of the week. (continued) eps81356_02_c02_045-096.indd 52 Richard Levine/age fotostock/SuperStock Darden, which operates the restaurant chains Red Lobster and Olive Garden, chooses to report its financials on the last Sunday of each period because it helps the company compare the results of its various brands. 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 World of Business (continued) For example, Friday and Saturday are the busiest nights for many restaurants. Monday night tends to be the quietest. Preparing reports that measure revenue based on the same ending day of the week provides more consistent reporting that is easier to compare period to period. Managers in businesses that are dependent on traffic flows based on the day of the week can more easily manage the finances of their business with numbers generated based on that traffic flow. However, reporting by the day of the week can add another complication to analyzing results of operations. This is because in some years, there will be 52 weeks, and in other years there will be 53 weeks. A company that uses this type of year-end reporting will explain how it calculates its results in the Notes to the Financial Statements. Darden discusses its fiscal year on page 68 of its 2012 annual report. The three years 2012, 2011, and 2010 were 52-week years. The last 53-week year was 2009. It is discussed on page 47 of the 2009 Darden annual report. When financial statements show an end date other than the 30th or 31st of the month, look for the discussion of the 52/53-week year in the Notes to the Financial Statements. Also, when comparing companies, be sure to either find another company with a similar fiscal year or adjust the results to compare performance during the same time period. (Darden 2012) Consider This: 1. 2. 3. You want to compare a restaurant chain that reports based on weekly financial data to one that reports on a calendar-year basis. What are the key differences you must consider in the way the figures are reported? What benefits do you think companies gain by reporting on a weekly schedule versus a monthly schedule? What types of businesses do you think might best be served by weekly reporting? Numbers Used In addition to knowing the date the report was generated, it is important to pay attention to the way the numbers are shown. For example, IBM's Financial Position Statement says \"$ in millions except per share amounts.\" This is a critical piece of information and is found at the top of all financial statements. Imagine how difficult it would be to read all the numbers IBM includes on its financial statements if the numbers were shown without roundinga mathematical decision to use less exact, abbreviated numbers. For example, if sales were $12,275,645,320 and the company reported in the millions, the number would be shown as $12,276. In this case, the company rounded up because the next number was 5 or more. If the next number had been 4 or less, the number would be shown as $12,275. Companies normally provide their numbers in the thousands or millions, but either way, it is important to note how a company is rounding its numbers. This can be critical when comparing the results of a large company, which may report its numbers in the millions, to that of a mid-sized or small company, which may report its numbers in the thousands. Presentation Format Companies can use three different types of formats when presenting their balance sheet: report format, account format, or financial position format. We present each format using simple numbers and just a few line items to illustrate what to expect for each. eps81356_02_c02_045-096.indd 53 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet For the Best General Company, we used the report format, which is shown in Figure 2.3. Figure 2.3: Report format balance sheet In the report format, Assets are shown first, then Liabilities and Equity. Note that Assets 5 Liabilities 1 Equity. Best General Company Balance Sheet (Report Format) At December 31, 2013 Assets Current Assets Long-Term Assets Other Assets Total Assets $ 62,200 90,000 45,000 197,200 $ Liabilities and Equity Current Liabilities Long-Term Liabilities Total Liabilities Shareholders' Equity Total Liabilities and Equity $ 55,300 114,450 169,750 27,450 197,200 $ Another commonly used format is the account format, shown in Figure 2.4. Figure 2.4: Account format balance sheet In the account format, the Assets are in the left column and the Liabilities and Equity are in the right column. The two columns' totals will always be shown in balance. Best General Company Balance Sheet (Account Format) At December 31, 2013 Assets Liabilities and Equity Current Assets Long-Term Assets Other Assets $ 62,200 90,000 45,000 Total Assets $ 197,200 eps81356_02_c02_045-096.indd 54 Current Liabilities Long-Term Liabilities Total Liabilities Shareholders' Equity Total Liabilities and Equity $ $ 55,300 114,450 169,750 27,450 197,200 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet The third format is the financial position format. This format is used internationally but is not commonly found in the United States, although it may be used by foreign companies that do business in the United States. The key difference in this format is the addition of two lines that do not appear on the account or report formats: Working Capital: This line is the current assets the company has available to pay its bills. It is calculated by subtracting the current liabilities from the current assets. Net Assets: This line shows what is left for the company's owners after all liabilities have been subtracted from total assets. Using the same numbers as are seen in the examples of the other two formats, the financial position format is shown in Figure 2.5. Figure 2.5: Financial position format balance sheet Net Assets is equal to Shareholders' Equity. Companies using this format also include a statement detailing the equity section. Best General Company Balance Sheet (Financial Position Format) At December 31, 2013 Current Assets Less: Current Liabilities Working Capital Plus: Non-Current (Long-Term) Assets Total Assets Less Current Liabilities Less: Long-Term Liabilities Net Assets $ $ 62,200 (55,300) 6,900 135,000 141,900 (114,450) 27,450 Now that we have reviewed the items that appear on a balance sheet or statement of financial position, we will investigate the most common line items and how these line items are calculated. We also will explore the Notes to the Financial Statements, which provide the details behind these numbers. eps81356_02_c02_045-096.indd 55 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Task Box 2.2: Exploring Notes on Financial Statements Take a look at the 2012 financial statements you downloaded for IBM and 3M. You will see that IBM's Statement of Financial Position makes it easy to find out more details about its line items because the appropriate note is indicated in a column called Notes. The first note you will see is Note D, on the line item Marketable Securities. If you turn to the Notes to the Financial Statements, you will find out more detail about IBM's marketable securities. The balance sheet for 3M is not as helpful. There is only one note mentioned on the statement (Note 13, Commitments and contingencies), but 3M does provide an index of its notes on page 43 of its 2012 annual report. Assets As we discussed in Chapter 1, assets are divided into two groups: current assets and longterm assets. Current assets include those that will be used in the next 12 months. All other assets are considered long-term assets (also sometimes called non current assets). The current assets are shown first, followed by the long-term assets. As a review, Figure 2.6 shows the assets section of Best General Company's balance sheet. Figure 2.6: Assets section of Best General Company balance sheet Long-term, or non-current assets, are assets that will not be used within the next 12 months. These assets are listed after all current assets on the balance sheet. Best General Company Balance Sheet (Partial) At December 31, 2013 and 2012 2013 Assets Current Assets: Cash Accounts Receivable Inventories Other Current Assets Total Current Assets Long-Term Assets: Property, Plant, & Equipment Less: Accumulated Depreciation Other Non-Current Assets Total Assets eps81356_02_c02_045-096.indd 56 $ 8,400 7,800 40,000 6,000 62,200 2012 $ 9,500 7,200 38,000 6,000 60,700 99,600 (9,600) $ 99,600 (7,200) 45,000 197,200 45,000 198,100 $ 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 Cash and Cash Equivalents The first line item on the balance sheet is always Cash or Cash and Cash Equivalents. Cash is just that: cash in bank accounts, savings accounts, cash registers, and petty cash drawers. For Best General Company, Cash and Cash Equivalents was $8,400 in 2013. On the balance sheets of more complicated companies, cash may include many different types of financial instruments. For example, IBM explains what it considers Cash Equivalents in Note A of its Notes to the Financial Statements: \"All highly liquid investments with maturities of three months or less at the date of purchase are considered to be cash equivalents.\" For example, a three-month Certificate of Deposit (CD) would fit into this category. In Note D, IBM details that Cash includes time deposits, certificates of deposit, commercial paper, money market funds, and other securities. In Note 1, 3M explains this line item in a similar way: \"Cash and cash equivalents consist of cash and temporary investments with maturities of three months or less when acquired.\" (Maturity refers to the date the asset can be turned into cash. For example, if the asset is a CD, this will be the date the CD must be turned into cash or reinvested in another CD.) When comparing how one company reports its cash to how other companies do it, look at the explanation to be sure both companies use the same categorization of cash. In Chapter 1 we discussed that the first note in the Notes to the Financial Statements reviews significant accounting policies. When searching for details about how a number is calculated (and the information is not presented in a separate note), look for that information in Note 1 or Note A, depending on how the company numbers its notes. Marketable Securities Marketable securities can include stocks, bonds, and other investments that can be turned into cash within 12 months. The simple balance sheet for Best General Company did not show any marketable securities, but many major corporations will include this line item. Financial managers are likely to take a close look at this information. For example, Bob, a financial analyst at Best General Company, would likely check competitors' balance sheets to find out if they hold marketable securities and which types of securities they hold. He could use this information to make recommendations to his managers. If Bob were looking at IBM and 3M, he would review the relevant Notes to the Financial Statements. He would see, for example, 3M's balance sheet includes two marketable securities line items: one is current and another is non-current. In Note 8, 3M explains that classification as current or non-current marketable securities is determined by \"management's intended holding period.\" The note also indicates that 3M's marketable securities include U.S. and foreign government securities, commercial paper, corporate debt, and asset-back securities (such as automobile loans and credit card securities). Also at the bottom of Note 8, 3M details its unrealized gains and losses on marketable securities and how it derives the valuation for the balance sheet. eps81356_02_c02_045-096.indd 57 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 IBM explains in Note A that all securities on this line item can be turned into cash in the next 12 months. IBM also explains that realized gains and losses on these securities are included in Other Income or Other Expense on the income statement (statement of earnings). These gains or losses are calculated based on the specific identification method, which means they are based on the purchase and sold details of each individual asset. In addition, IBM says these assets are reported at \"fair value with unrealized gains and losses, net of applicable taxes.\" Note D includes a detailed breakdown of the marketable securities owned by IBM as well as explanations about fair value calculations. IBM also details the risks involved with its marketable securities. With the details found in the notes, Bob can assess how well his company is managing its marketable securities compared to how the competition is managing theirs. Task Box 2.3: Comparing Marketable Securities Review the details behind IBM's and 3M's marketable securities in their 2012 financial statements. How much does each show in unrealized gains and unrealized losses for the two years? Which company makes it easier for you to answer this question? Explain why. Accounts Receivable Accounts Receivable is where the company tracks money due from its customers. Note that these are customers who bought on credit offered directly by the company. Customers who use credit cards are not included in this number because the company will receive immediate cash payment from the credit card company, which in turn collects from the customers. As indicated above, the budget committee for Best General Company would need to take a close look at the details for this account since the value of this asset went up from $7,200 in the prior year to $7,800 in the current year, even though revenue went down. This likely means more customers are not paying their bills, but the budget committee cannot know that for sure until it looks at the internal reports that detail what is behind these numbers. Internally, the budget committee can request an aging schedule, which would be a confidential report not found in the financial statements released to the public. This report might look something like the one shown for Best General Company in Figure 2.7. eps81356_02_c02_045-096.indd 58 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Figure 2.7: Best General Company accounts receivable aging schedule An aging schedule, like the one shown here, is an internal report showing customer credit delinquencies that are more than 30 days past due. Best General Company Accounts Receivable Aging Schedule As of December 31, 2013 Customers Sally Adams Jerry Jones Andy King Total 30-45 Days $ $ 100 100 200 46-60 Days $ $ 150 300 150 600 61-90 Days $ $ 500 300 300 1,100 Over 90 Days $ 900 $ 900 Total $ $ $ $ 750 1,500 550 2,800 A complete aging schedule would list all the customers and what they owe. The amount owed is grouped by the \"age\" of the purchase, such as 30 to 45 days or 46 to 60 days. Since Best General Company is experiencing an increase in its Accounts Receivable line item, it is likely that a greater number of its customers are paying their bills late. The budget committee may need to recommend changes to Best General Company's credit policies. The executive committee would then need to determine whether a change is needed and how that change should be implemented. When looking at their competitors' Accounts Receivable line item, Best General's budget committee could not see this type of detail, but they can assess whether their competitors are experiencing similar problems. If so, it could be an indication of an industry-wide downturn or possibly even economic problems impacting a larger portion of the nation's economy, such as the recession the United States experienced between 2008 and 2012. If economic conditions are impacting receivables, the budget committee may need to lower revenue expectations for the next year. Every company reports some detail about its Accounts Receivable in the Notes to the Financial Statements. Note that IBM actually includes three Accounts Receivable line items: notes and accounts receivable, short-term financing receivables, and other accounts receivable. Also note that IBM shows these numbers \"net of allowances.\" These allowances are for bad debt, which means the amount of this debt that IBM does not expect to be able to collect from nonpaying customers. There are also allowances for returns. In Note A, IBM details how it calculates its allowance for credit losses. In Note F, IBM details its short-term financing receivables. IBM sells large computer software systems and services that are purchased using leases and long-term loans, so its Accounts Receivable can be very complex to sort out. eps81356_02_c02_045-096.indd 59 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 Accounts Receivable is only one line item on 3M's balance sheet. Its product offerings are not as complex as IBM's, and there aren't many details about its Accounts Receivable and allowances. In Note 1, the company explains that the allowance for doubtful accounts (bad debt) is \"based on historical write-off experience by industry and economic data and historical sales returns.\" The company says it reviews this data monthly. Inventories Inventories include the products the company has on hand to sell to its customers. When Best General's budget committee looks at this number, it sees that the value of inventories is climbing from $38,000 in the prior year to $40,000 in the current year. If more inventory is on hand, this could indicate that business has slowed. Susan, the marketing manager, and Juan, the sales manager, would need to compare the sales reports to find out what products are selling and whether sales have dropped. Mai and Frank would want to compare their inventory numbers to those of their competitors to see whether their competitors are also experiencing an increase. If they are, it could be a sign of an industry downturn. If the competitors do not show the same problem, it could be an indication of a company-specific issue. Either way, the budget committee would need to research why inventory is building up. When looking at competitors, another factor could be of interest to the budget committee: whether their competitors manufacture the products they sell. For example, IBM includes only one line item for inventories, whereas 3M includes three stages of inventory: finished goods, work in process, and raw materials and supplies. The primary reason for this difference is that 3M has a major manufacturing component. The only goods ready for sale are finished goods. The value of goods in work in process includes the value of goods currently in some stage of the manufacturing process but not yet ready for sale. Raw materials and supplies are goods on hand that have not yet entered the manufacturing process. In Note 1, 3M states it values its inventory \"at the lower of cost or market, with cost generally determined on a first-in, first-out basis.\" We explore what this means and how companies value inventory later in this chapter. IBM does manufacture some of its products, but it does not show the detail on the balance sheet. Instead, the notes reveal information about its inventories. IBM only provides details for finished goods separately. Work in process and raw materials are shown as one line item in Note E. In Note A, IBM details its hardware and software products, as well as the services offered, but the focus in this note is on how the company recognizes its revenues. We'll investigate those issues in Chapter 3. Deferred Taxes Some larger companies carry over tax deductions for another year. IBM is one company that carries assets on its balance sheet on a line item called Deferred Taxes. The item appears both as a current asset and as a long-term asset. The details about this line item can be found in Note N. IBM shows its income before taxes in both U.S. and foreign operations, then goes on to detail its taxes by geographic operations and taxing jurisdictions. eps81356_02_c02_045-096.indd 60 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet The key part of this note that affects deferred taxes can be found in a chart called Deferred Tax Assets (see Figure 2.8). Deferred taxes are an asset to a company because they represent tax write-offs that may be used to reduce income taxes in the future. Figure 2.8: IBM's deferred tax assets Using deferred tax assets on future tax returns, companies can reduce their tax obligations in the future. Deferred Tax Assets ($ in millions) At December 31: Retirement benefits Share-based and other compensation Deferred income Domestic tax loss/credit carryforwards Foreign tax loss/credit carryforwards Bad debt, inventory and warranty reserves Depreciation Other Gross deferred tax assets Less: valuation allowance Net deferred tax assets 2012 $ $ 5,870 1,666 1,018 954 681 586 456 1,384 12,615 1,187 11,428 2011 * $ $ 5,169 1,598 834 914 752 608 474 1,479 11,828 912 10,916 *Reclassed to conform with 2012 presentation. Source: IBM. (2013). 2012 annual report. Retrieved from http://www.ibm.com/annualreport/2012/bin/assets/2012_ibm_annual.pdf Prepaid Expenses Prepaid expenses include expenses paid in advance and not yet used. For example, a company pays an insurance policy on the first of the year that will cover the company for 12 months. The company must record the transaction when it occurs, but it will record it as an asset initially. Each month it will develop an adjusting entry to the books to show the amount of this asset used and offset it with an insurance expense. This way, the expense will be matched with the revenues generated that month. The expense account will be shown on the income statement. This is a basic concept of accrual accounting, in which expenses and revenues are shown in the appropriate month. Revenues must be recognized in the month they are earned and expenses must be recognized in the month they are used, which is not necessarily the month that cash changed hands. Best General Company did not show any prepaid expenses. IBM lumps these with other assets, whereas 3M does not show the item on its balance sheet. eps81356_02_c02_045-096.indd 61 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 Other Current Assets Other Current Assets is a miscellaneous line item for anything not detailed in the current assets portion of the balance sheet. Usually this item reflects the value of assets not used in current operations (and possibly up for sale). Neither IBM nor 3M details what is included in the Other Current Assets line item. Property, Plant, and Equipment Up until now we have discussed current assets on the balance sheet. The rest of the assets on the balance sheet are long-term assets. These assets will be used for more than just a 12-month period. The property, plant, and equipment line item is one such long-term asset. It will summarize the value of all the land, buildings, plants, laboratories, and office equipment on hand. It may include the value of rental equipment, as well, if that equipment is likely to become an asset at the end of the rental or lease period. To keep things simple, Best General Company showed property, plant, and equipment net, which means after the reduction for depreciation. Note that there are three Property, Plant, and Equipment lines on both the IBM and 3M balance sheets. The first line item shows the gross value of property, plant, and equipment. The second line item shows the reduction in that value for depreciation. Depreciation indicates how an asset is being expensed over its lifespan. For example, a vehicle that is expected to have a useful life of five years would be depreciated over that five-year period. That way its cost is spread over five years rather than being subtracted all in one year. The accumulation of depreciation over the five-year period is shown on the balance sheet as accumulated depreciation. The third line item on IBM's and 3M's balance sheets is the net value of property, plant, and equipment after depreciation is subtracted. Managers need to understand how depreciation reduces the net income of a company, but it is not actually a cash expense each year. The cash outlay (or initiation of a long-term debt, such as a car loan) for an asset happens in the year of purchase. If a company were to report that as an expense, the profits would be greatly reduced. Depreciation expenses spread out the cost of an asset over time, even though they do not require the use of cash. This enables a company to match its expenses with the time over which the asset is used. Task Box 2.4: Calculating Depreciation Review the Notes to the Financial Statements and find out how 3M and IBM calculate depreciation. (The method 3M uses to calculate depreciation is shown in Note 1, page 53. IBM details this on page 81 in Note A.) List the different classes of depreciated assets and the number of years of useful life each company gives for its various types of assets. What depreciation method does each company use? eps81356_02_c02_045-096.indd 62 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Most companies use a straight-line depreciation method on their balance sheet. This means that the company determines an asset's life span and then divides the cost of that asset by the number of years it will have a useful life to the company. If there will be a value after its useful life to the company, that is the salvage value at which the item could be sold to generate cash. If the company does not believe there will be a salvage value, the asset may be able to be sold for scrap. Whether salvage or scrap, any value the company can get for the item will be subtracted from its cost prior to calculating the annual depreciation amount. For tax purposes, the company may use a depreciation method, called accelerated depreciation, that speeds up the deduction the company can take for the item. This will not be shown on the balance sheet. Occasionally, a company will detail a different method of depreciation in its note called \"Significant Accounting Policies.\" In addition to detailing its depreciation calculation, IBM also separates out its Property, Plant, and Equipment in greater detail in Note G (see Figure 2.9). Figure 2.9: IBM's Note G (2012) One can find details about IBM's property, plant and equipment by reviewing the notes to the financial statements. Note G. Property, Plant and Equipment ($ in millions) At December 31: Land and land improvements Building and building improvement Plant, laboratory and ofce equipment Plant and other propertygross Less: Accumulated depreciation Plant and other propertynet Rental machines Less: Accumulated depreciation Rental machinesnet Totalnet 2012 $ $ 747 9,610 27,731 38,088 25,234 12,854 2,414 1,271 1,142 13,996 2011 $ $ 786 9,531 26,843 37,160 24,703 12,457 2,964 1,538 1,426 13,883 Source: IBM. (2013). 2012 annual report. Retrieved from http://www.ibm.com/annualreport/2012/bin/assets/2012_ibm_annual.pdf Note that land and land improvements are not shown with net of accumulated depreciation. This is because land does not age and become useless, as other assets do. Buildings and building improvements are shown separately from plant and office equipment, but they are shown as total plant and other property for depreciation purposes. eps81356_02_c02_045-096.indd 63 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 Depreciation of a building can be a complex calculation. Some accountants use cost segregation (dividing up a building's structural components so write-offs can be developed based on the useful life of various key parts of a building; for example, a roof may age more slowly than the doors). We can't determine by reading the Notes to the Financial Statements whether either IBM or 3M uses cost segregation, but since they do separate buildings from other property, that may explain the separation. (Soled, 2004) When looking at depreciation, note what percentage of the assets has been depreciated. As we can see in Figure 2.9, IBM shows a gross value of $38,088 million for plant and other property, but $25,234 million has already been depreciated with only $12,854 million left to depreciate. This indicates that 66% (25,234/38,088) of the useful life of its assets has been used up. This could mean IBM may need to spend a good deal of money repairing older facilities or building new facilities to maintain operations. Task Box 2.5: Comparing Age of Assets As a manager, when comparing your company to a competitor, you may want to consider the age of your competitor's property, plant, and equipment. A company with newer equipment will have higher depreciation costs but may have lower repair expenses. So when comparing these line items to analyze operating costs, you may need to consider both depreciation expenses and repair expenses. This calculation can also make a big difference when preparing budgets. If a company has mostly older assets, the budget committee may need to plan for the purchase of new assets or may need to plan for more repairs to facilities and equipment. Calculate the age of the assets of 3M using a similar calculation to the one shown for IBM and compare the age of assets for the two companies. When evaluating the value of a company, depreciation can give you a clue about the age of the company's assets. Prepaid Pension The Prepaid Pension line item summarizes the assets on hand to pay for the company's pension plans. We did not show a pension line item on the Best General Company's simplified balance sheet, but managers will likely see them on company balance sheets, so let's take a closer look at 3M's and IBM's information. Both 3M and IBM have complex plans that differ based on the date of hire and by the country from which one works. 3M's Note 10 indicates that the company has over 70 plans in 25 countries. The assets are offset by the obligations each company has to pay its retirees from these assets. Note that for both companies, the pension and post retirement benefits on the liabilities side are much higher than the prepaid pension assets shown on the asset side. The notes explain how each company structures its retirement benefits and how well funded each benefit may be. For many companies, pension obligations are like a ticking time bomb that may explode as the Baby Boomers retire in large numbers. This future obligation could be a drag on a company's long-term earning potential, draining a company's cash that could instead be used for future growth. eps81356_02_c02_045-096.indd 64 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 IBM states in Note S that it ceased defined benefit accruals on December 31, 2007. This means that after that date, employees ceased to build defined benefitsthe type of benefits in which an employee gets a set amount per year based on a formula calculated by the employee's years of service and salary for the rest of his or her life after retirement. Today, all IBM employees participate in a defined-contribution plan. In this type of plan, employees, and possibly their employers, contribute to the plan. Retirement benefits are based on the cash saved in this retirement plan. The 401(K) is an example of a defined contribution plan. In Note 10, 3M states that its defined-benefit plan in the United States was closed to new participants on January 1, 2009. The company currently offers defined-contribution plans to all its employees. Changes to pension plans for subsidiaries outside the United States are also detailed in this note. Goodwill Goodwill is an intangible asset (an asset that cannot be touched or felt but that has value for the company). This asset is built by acquiring companies whose value is greater than the physical or tangible assets the company holds. In other words, when a company shows goodwill on its balance sheet, it means it paid more for at least one company than its tangible assets were worth. Often these intangible assets include things like customer base, desirable locations, or popular technology, products, or services. We do not show goodwill on Best General Company's balance sheet, but both IBM and 3M show goodwill on their books, and both companies have bought many smaller companies over the years. Details about IBM's goodwill are located in Note I, whereas 3M's are located in Note 3. Both companies show goodwill broken down by industry segments, but they do not provide much more detail. More information about recent acquisitions is located in Note 2 for 3M and Note C for IBM. The acquisition note contains specific financial details about the company's recent acquisitions. For example, if the company has sold any divisions, that information is usually found in the acquisitions note, which is then called Acquisitions/Divestitures. Only IBM details divestitures. Intangible AssetsNet Goodwill is not the only intangible asset on a balance sheet. Intangible assets also include things such as: Copyrights: Original works such as books, film, audio, software, and drawings can be protected for between 50 and 100 years after the creator's death, assuming the creator is an individual. The time is shorter for a corporation. Trademarks: These include symbols, logos, phrases, or combinations of these that legally distinguish the company. Patents: The exclusive right to an invention, design, or process for a designated period of time. eps81356_02_c02_045-096.indd 65 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 All non-goodwill intangible assets are usually lumped in one line and shown as \"net.\" This means that the asset's value is shown minus any reduction for amortization. Amortization is similar to depreciation. Many intangible assets have a limited life span. Amortization is used to track the aging of these assets and to show what portion of these assets has been used up. Neither IBM nor 3M shows much detail in its Intangible Assets note. IBM shows some information in Note I, and 3M includes information in Note 3. IBM has two line items on its balance sheet that we will not explore in detail: Long-Term Financing Receivables and Deferred Taxes. The Long-Term Financing Receivables is a long-term account similar to the Current Assets account discussed above. Deferred taxes also was discussed above as a current asset. The only difference between these items and the respective Current Asset line items above is that these items will be useful for more than 12 months. The details for the line items can be found in the notes cited above. Other Assets Other Assets is a catchall category for assets not shown individually on the balance sheet. IBM calls this line item \"Investments and sundry assets.\" Some detail can be found in Note H, but not much. There is no note specifically for other assets in 3M's financial reports. Let's now examine the Liabilities section of the balance sheet more thoroughly. Liabilities Liabilities include things the company owes. Just as we saw with assets, there are two groupings: current liabilities (money due within the next 12 months) and long-term liabilities (money due in more than 12 months). Financial analysts for Best General Company would be most interested in the liabilities side of the balance sheet. They would want to test the company's ability to pay its debts, both in the short term and long term. (We will discuss how to test that in Chapter 6.) In this chapter, we explain the various types of liabilities that a company might incur. In the beginning of this chapter we saw the balance sheet of the Best General Company. Let's take a closer look at its liability section and compare it to those sections from IBM and 3M. Figure 2.10 is the liability section of Best General Company balance sheet. eps81356_02_c02_045-096.indd 66 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Figure 2.10: Liabilities section of Best General Company balance sheet The liabilities section of the balance sheet is set up just like the assets section, listing both current and long-term liabilities. Best General Company Balance Sheet (Partial) At December 31, 2013 and 2012 2013 2012 Liabilities Current Liabilities: Accounts Payable Short-Term Debt Other Current Liabilities Total Current Liabilities Long-Term Liabilities: Long-Term Debt Other Non-Current Liabilities Total Liabilities $ $ 8,900 26,000 20,400 55,300 62,450 52,000 169,750 $ $ 9,400 26,000 19,800 55,200 65,000 54,000 174,200 Taxes Best General Company shows no tax liabilities, nor does 3M, but IBM starts its 2012 Current Liabilities section of the balance sheet with a line item called Taxes. These are deferred tax liabilities that IBM must pay during 2013. They are explained in Note N along with Deferred Tax Assets. Corporate taxation can be a course in itself, and its discussion goes beyond the scope of this course. IBM states that its tax deferrals are related to foreign and domestic loss carryforwards (deductions for losses that could not all be taken in the current year but can be taken in future years). When comparing companies, this can be a critical issue if the taxes represent a significant portion of liabilities due. For IBM, the deferred tax liabilities of $6,508 million are offset by $11,428 million in deferred tax assets. Look in the notes to find out why the company is deferring such a large portion of its taxes due. It is possible the company is in negotiations with the IRS regarding tax obligations. If so, the company will detail the information in the notes. For example, IBM states that in the fourth quarter of 2011, the IRS started an audit of its U.S. tax returns for the years 2008 through 2010, and IBM expects the audit to be complete in 2013. When that audit is complete, any changes to IBM's tax bill will be reported in a future report to shareholders. eps81356_02_c02_045-096.indd 67 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Short-Term Debt Short-term debt includes all debt payments that must be made in the next 12 months. This is the second line item of Best General Company's current liability section of the balance sheet as shown in Figure 2.10. IBM details this further for its balance sheet in the notes to the financial statements. In the notes it breaks down short-term debt into three line items, as shown in Figure 2.11: Commercial paper is often used to finance accounts receivable, inventories, and other cash needed to meet short-term needs. Short-term loans are loans due in full during the next 12 months. Long-term debtcurrent maturities shows the amount the company will have to pay on the interest and principal due in the next 12 months for long-term debt borrowings. IBM includes the current portion of its long-term debt as part of its short-term debt detail in Note J (shown in Figure 2.11). IBM also indicates that the weighted-average interest rate was 1.8% in 2012 and 1.2% in 2011 for short-term debt. Figure 2.11: IBM's Note J In the notes to the financial statements, a chart shows a detailed breakdown of IBM's debt obligations. Note J. Borrowings Short-Term Debt ($ in millions) At December 31: Commercial paper Short-term loans Long-term debtcurrent maturities Total 2012 $ $ 1,800 1,789 5,593 9,181 2011 $ $ 2,300 1,859 4,306 8,463 Source: IBM. (2013). 2012 annual report. Retrieved from http://www.ibm.com/annualreport/2012/bin/assets/2012_ibm_annual.pdf 3M gives this line item a longer name: Short-term borrowings and current portion of longterm debt (see Figure 2.12). The detail for this line item is in Note 9. Note that 3M does not use commercial paper as part of its short-term borrowings, but it does have a line item for other borrowings, with an effective interest rate of 4.7%. eps81356_02_c02_045-096.indd 68 3/25/14 3:11 PM Section 2.1 The Elements of a Balance Sheet Figure 2.12: 3M's short-term borrowings and current portion of long-term debt This chart from the notes to the financial statement shows the details about IBM's short-term debts. Short-Term Borrowings and Current Portion of Long-Term Debt (Millions) Current portion of long-term debt U.S. dollar commercial paper Other borrowings Total short-term borrowings and current portion of long-term debt Effective Interest Rate 3.85% % 4.70% 2012 $ $ 986 99 1,085 2011 $ $ 563 119 682 Source: IBM. (2013). 2012 annual report. Retrieved from http://www.ibm.com/annualreport/2012/bin/assets/2012_ibm_annual.pdf Note that 3M also details the current portion of its long-term debt (the interest and principal of the loan that is due during the next 12-month period). This is separated out because this part of long-term debt is a current debt, whereas the rest of the money owed on longterm debt will be paid after the next 12-month period. Both IBM and 3M detail their types of borrowing in their respective notes. This information is critical to a company's financial managers. They need to be fully aware of the amount of borrowing, type of borrowing, and the interest rates the company pays on its borrowings. Interest can be a drag on earnings, so it is important to pay close attention to how the company is managing its debt. For example, Bob, as the financial analyst for Best General Company's budget committee, would need to look closely not only at how his company structures its debt, but he may want to review the debt structure of his company's competitors. He may discover ideas for how to better structure his own company's debt by reviewing his competitors' financial obligations. If Bob can develop a plan to lower his company's interest payments, he could improve his company's net income and impress his managers. Accounts Payable The Accounts Payable line item represents bills that were received in the previous year but have not yet been paid. Companies must record expenses at the time they are incurred (when bills were received) even if they have not yet paid cash to cover those expenses. For example, suppose a company gets a bill at the end of December 2012 for inventories sold in 2012, but the payment is not due until January 2013. The company must report the receipt of the bill in 2012. These bills are tracked in an account called Accounts Payable. Companies do not usually discuss this number in detail in the Notes to the Financial Statements. This is a basic rule of accrual accounting and there usually is no need to detail the number. eps81356_02_c02_045-096.indd 69 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 Accrued Payroll The Accrued Payroll account tracks payroll expenses that have not yet been paid. At the end of the year, it is not uncommon for companies to owe money to employees that will be paid at the beginning of the next year. For example, suppose employees are paid every two weeks, and one week falls in the last week of December 2012 and the second week falls in the first week of January 2013. The money due employees for that last week in December will be paid in the first week of January 2013. The company needs to include the December 2012 expense in the 2012 reports, so it accrues the one week at the end of December in an account called Accrued Payroll. When the employees are paid in January 2013, that accrual will be reversed to zero. Deferred Income Deferred income is a line item found on the balance sheets of service businesses that get paid up front for services, training, installation, construction, or other items before they have completed the work. The Deferred Income account is therefore a liability account because the company has not yet earned the money. Some companies call this Unearned Revenue. Only IBM shows a line item for deferred income. It does not include a specific note for this line item, but this liability represents income that has been received but not yet earned. Note that in the next chapter, we will examine revenue recognition in more detail when we discuss the income statement. IBM indicates how it recognizes income in Note A. Other Liabilities Other Liabilities is a catchall account for any current liabilities not shown as an individual line item. Companies rarely detail their Other Liabilities line item, and neither 3M nor IBM includes a note to explain what these liabilities include. Long-Term Debt Up until this point, we have examined short-term liabilities. We will now turn our attention to long-term liabilities. Recall that these are liabilities that will be paid over a period longer than 12 months. The amount of interest or principal due on these long-term liabilities was shown in a current liability called Current Portion of Long-Term Liabilities. Best General Company includes just one line item called Long-Term Debt, but more details can be seen when looking at the long-term debt explanations of IBM and 3M. IBM details its long-term debt in Note J, whereas 3M details it in Note 9. The details show the bonds or notes outstanding with information about the interest rates on each debt security and the date of maturity. IBM's Note J shows that IBM's long-term debt ranges from 2.7% to 7.125%. IBM also holds debt in foreign currencies, including the Euro, Japanese Yen, Swiss Franc, and Canadian dollar. IBM separates its U.S. debt and details each debt type, but it does not show individual details for each debt held in a foreign currency. eps81356_02_c02_045-096.indd 70 3/25/14 3:11 PM The Elements of a Balance Sheet Section 2.1 3M's Note 9 explains that the company combines U.S. and foreign debt instruments and details each holding. Its interest rates range from 0.0% to 6.01%. The dates of maturity for this debt range from 2013 to 2044. Why do these numbers matter? The interest rates show that 3M was able to negotiate better terms on its debt. When reviewing the long-term debt of his competitors, Bob, Best General Company's financial analyst, will assess whether the interest rates his company is paying on long-term debt are reasonable compared to those of the competitorsjust as he did with short-term debt, and for the same reason. Any opportunity to reduce interest payments has a positive impact on a company's net income. Both IBM and 3M show a weighted average for interest rates on their debt. (To calculate weighted average, the interest rate for each debt instrument is given a weight to determine the relative importance of each quantity on the average. A $50,000 debt at 4% would have a larger weight than a $10,000 debt at 5% because more of the interest is generated by the larger debt. IBM's weighted average interest rate is 3.43% and 3M's is 3.16% on longterm debt. The difference is just 0.27%, which may not seem like much, but for IBM, that extra 0.27% translates into about $65 million ($24,049 million 3 0.27 percent) in interest expenses on its fixed-rate debt. Another key factor to look at when reviewing a company's long-term debt is to determine whether a company is paying down debt or adding to that debt. IBM's fixed-rate debt increased from $18,547 million in 2011 to $24,049 million in 2012. The story is somewhat similar for 3M, which also increased its long-term debt in 2012. Long-term debt for 3M was $5,047 million in 2011 and $5,902 million in 2012. For IBM, long-term debt is 12.1% (24,088 million/199,213 million) of its total assets. For 3M, long-term debt is 14.5% (4,916 million/33,876 million) of its total assets. Companies with lower debt, like IBM and 3M, can negotiate better interest rates. If the two companies were competing in the same industry, the company with the lower weighted average and the same level of debt would likely have lower interest rate expenses and highe