Figure 1.6 presents the balance sheet of Happy Valley Hospital on December 31, 20X1. Notice that the statement heading consists of (1) the name of the accounting entity, (2) the name of the statement, and (3) the date of the statement. These three elements should always be included in the heading of the balance sheet.
The accounting entity in this case is Happy Valley Hospital. This is one of the most important and basic accounting concepts. Under this concept,
Assets Liabilities and Net Assets
Accounts payable $ 300
Notes payable 275
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the hospital is personified as an entity (being) separate and distinct from its governing board, management, and employees. The hospital is regarded as a
“person” capable of owning property, incurring debts, buying and selling, rendering services, and taking other economic actions. Thus, you can say that
“the hospital purchased equipment,” “the hospital borrowed $100,000 from the local bank,” or “the hospital paid $160,000 of salaries and wages to its employees last month.” The accountant thinks of the hospital as an entity for whose economic activity a financial record must be kept. The object of the accountant’s attention and effort is the hospital itself, not the personal affairs of board members, managers, and employees. Activity recorded in the hospi-tal accounting records is limited to the financial affairs and business transac-tions of the hospital as an economic unit or entity in its own right.
As noted earlier, the name of this financial statement is balance sheet, but you should be aware of alternate titles, such as statement of financial position. The name most widely used, however, is balance sheet, and this term will be used throughout this book.
The date of the Happy Valley Hospital balance sheet is December 31, 20X1, a specific point in time. A balance sheet is analogous to a snapshot that portrays a situation existing at a given moment. It is a “picture” of the finan-cial position of Happy Valley Hospital on December 31, 20X1, only. The pic-ture likely was somewhat different on December 30 and probably will be dif-ferent again on January 1, 20X2. This is true because business transactions occur every day, and consequently the dollar amounts of assets and liabilities also change daily.
Assets may be defined as the economic resources of the hospital that are recog-nized and measured in conformity with GAAP. As indicated in Figure 1.6, the assets of Happy Valley Hospital total $8,800 at December 31, 20X1. The fol-lowing is a brief explanation of each of the assets included in that balance sheet.
There are seven types of assets appearing on a hospital’s balance sheet. They include the following:
1. Cash is the amount of money on hand and in bank checking accounts maintained by the hospital.
2. Accounts receivable represent the amount of money due the hospital from patients and their third-party sponsors for services provided to them but for which the hospital has not yet been paid.
3. Inventory is the cost of food, fuel, drugs, and other supplies purchased by the hospital but not yet used or consumed.
4. Prepaid expenses include expense items such as insurance, interest, and rent that have been paid in advance. These items are assets in the sense that their prepayment will provide future benefits (e.g., insurance
Assets
Types of Assets
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protection, use of borrowed money, use of space or leased equipment) to the hospital.
5. Long-term investments represent the cost of governmental and corpo-rate securities that the hospital owns and intends to hold for a period of time in excess of one year.
6. Land, buildings, and equipment consist of the original acquisition costs of tangible plant assets used in hospital operations.
7. Accumulated depreciation reflects the amount of plant asset costs con-sumed by the use of the assets and treated as an operating expense of the hospital during the time that has elapsed since the assets were acquired.
Notice that accumulated depreciation is deducted from the cost of the plant assets and that only the remaining “undepreciated” balance of cost is included in the total assets reported in the balance sheet.
Items 1 through 4 are totaled and presented in the balance sheet as total current assets. For the present, think of current assets as consisting of cash plus other assets that will be converted into cash or consumed by oper-ations within one year from the balance sheet date. All other assets (items 5 through 7) are referred to as noncurrent assets, or long-term assets.
You have noticed that most assets are reported in the balance sheet at historical acquisition costs rather than current market values. Valuation of assets at cost is a basic accounting principle. This basis of valuation generally is employed in accounting because it is a permanent and objective measure-ment and because accountants assume that the monetary unit is reasonably stable; that is, that the purchasing power of money does not change materi-ally over time. This assumption, because of earlier inflationary trends, natu-rally has been challenged by various groups who argue that assets should be presented in balance sheets at either current fair values or estimated replace-ment costs. In fact, the FASB moved off the concept of historical costs for balance sheets in a major way in the mid-1990s when it issued SFAS No. 124, which says that not-for-profit organizations are required to report their investment balances at “market.” This was a significant change in authorita-tive accounting pronouncements with which all organizations had to comply.
There will be an expanded discussion of SFAS No. 124 later in the book.
Another point worth noting at this time concerns the sequence in which the assets are listed on the balance sheet. Observe that the sequence is generally in the order of liquidity. The most liquid asset (cash) is listed first; the least-liquid assets (land, buildings, and equipment) are last in sequence. This is standard practice in financial reporting.
Finally, you should understand that certain economic resources of the hospital are not included as assets in the balance sheet. A hospital may enjoy good public relations and high employee morale, but although these things Sequencing
of Assets
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may be regarded as valuable resources, they are not formally recognized as assets in hospital accounting. These items are excluded from reported assets because of the great difficulty involved in making an objective measurement of them in monetary terms. This problem is being studied, and perhaps someday a satisfactory solution will be forthcoming.
Liabilitiesmay be defined as the economic obligations of the hospital that are recognized and measured in conformity with GAAP. Following is a brief descrip-tion of the liabilities presented in the Happy Valley Hospital balance sheet.
There are five types of liabilities appearing on a hospital’s balance sheet. They include the following:
• Accounts payableare amounts owed by the hospital to suppliers and other trade creditors for merchandise and services purchased from them but for which the hospital has not yet paid.
• Notes payablegenerally consist of short-term borrowings by the hospi-tal from banks and other financial institutions. These debts usually are in the form of promissory notes issued by the hospital to the lender.
• Accrued expenses payable, sometimes known as accrued liabilities, are liabilities for expenses (employee salaries and wages, for example) that have been incurred by the hospital but for which the hospital has not yet paid.
• Deferred incomerepresents income (e.g., nursing school tuition) that has been received in cash by the hospital but that the hospital has not yet earned and for which it is obligated to provide some specific service in the future.
• Long-term liabilitiestypically are mortgage loans or hospital bond issues that will not be retired by the hospital in the near future (usually well beyond one year from the date of the balance sheet).
As you can see in Figure 1.6, items 1 through 4 are totaled and reported as total current liabilities—that is, obligations that mature and will be paid by the use of current assets within one year from the balance sheet date. The other liabilities of the hospital therefore are referred to as noncurrent liabilities, or long-term liabilities. Liabilities, generally speaking, are measured in terms of the dollar amounts that will be required to discharge them. Long-term liabilities, however, generally are reported in the balance sheet at the present value of the future payments required for their liquidation; but again, a discussion of this matter is postponed until later in the book.
As was true of assets, recognition problems also exist for liabilities. When is an obligation a liability in the accounting sense? As you pursue your study of this book, you will discover items you may consider liabilities that are not so
Liabilities
Types of Liabilities
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treated in accounting. Similarly, you may encounter accounting liabilities you have not previously regarded as such. This is but another example of the patience you must have in beginning your study of hospital accounting. Full explanations cannot be given of all matters in the first chapter; your complete comprehension of the various concepts and procedures mentioned in this chapter will eventually be achieved, but only through a gradual building-block process.
Liabilities are presented in the balance sheet more or less in the order in which they will be paid. The proper sequence, however, is not always easy to determine, and compromises often must be made. It is essential, however, that balance sheets report total current liabilities and total liabilities (current and noncurrent) as indicated in Figure 1.6. Users of the balance sheets of hospitals are entitled to this information.
Hospital net assets may be defined simply as the excess of hospital assets over hospital liabilities. They are the hospital’s residual ownership interest in its own assets after the claims of creditors against these assets are satisfied. Hos-pital net assets are increased by net income (excess of revenues over expenses); they are decreased by net loss (excess of expenses over revenues).
Net assets are sometimes referred to as equity, capital, or net worth.
Later on in this book, the subject of fund accounting is introduced.
Fund accounting is employed by many hospitals and consists basically of a seg-regation of assets, liabilities, and net assets into self-balancing groups of funds.
When this accounting procedure is used, a separate balance sheet can be pre-pared for each fund; or, a single balance sheet may be prepre-pared in which assets, liabilities, and net assets are classified and reported according to the particular fund with which they are associated. In a fund-accounting system, the net assets account of each fund generally is referred to as the fund balance.