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Objectives for the Day
1. Review Dr and Cr2. Classify and defineelements of the Bal/Sheet3. Compute some basic ratios based on Bal/Sheet
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Objectives for the Day
4. Explore why and howBalance Sheets of differingindustries may differ.5. Explore some creative accounting on the balancesheet.6. Select day for presentation.
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The Mystery of Dr and Cr
The basic sentence of Accountese is a “journal entry” which uses very easy visuals to tell you what is debited (Left) and what is credited – an Indentation (Right)….Cash $1,000 Accounts Rec $1,000
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Basic Accounting Equation A LOE Assets
INCREASE DR
Expenses
Liabilities
INCREASE CR Equities
Revenues
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Assets: A Company’s Resources
Basic Rule: Assets are recorded at acquisition cost (also called Historical cost).
Acquisition cost includes all costs to acquire the asset and get it ready for its intended use.
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Why does Valuation change? And why does it matter?
Acquisition IS Fair Value at the time an asset is acquired…but values may change. Valuation is the recognition of that fact. Important because..... Usually affects Income Can be very large in scope.
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Balance Sheet: Current Asset Section
•Represents sales payments that are due after the goods are delivered and the customer is billed
•Amounts owed to the company by customers
Accounts
Receivable
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Balance Sheet: Current Asset Section
Valuation: Net Realizable Value.
An allowance is deducted from accounts receivable to show the portion that is estimated to be uncollectible.
AccountsReceivable(lessallowance)
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Balance Sheet: Current Asset Section
The aggregate cost of salable merchandise owned by the company that is available to meet customer demands. Also materials to be used to mfg goods or provide services
4.Inventory
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Balance Sheet: Current Asset Section
Some estimates of current cost of inventory in US are $3 to 4 Trillion
Valuation: Lower of Cost or Market
4.Inventory
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Balance Sheet: Current Asset Section
Expenditures for the
prepayment of items
such as rent, insurance, or
taxes.
5. PrepaidExpenses
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NoncurrentNoncurrent Assets – Tangible or Fixed
Examples include:
Land
BuildingsEquipmentDelivery TrucksComputers
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Tangible Assets - Depreciation
The cost of all long-term tangible assets except Land is charged (i.e.
expensed or debited) to net income over its
estimated useful life.
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Tangible Assets - Depreciation
The entry requires a debit to Depreciation Expense and a credit
to a contra-asset called Accumulated Depreciation.
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Tangible Assets - DepreciationDespite the term “Net BookValue” we consider depreciationa cost allocation and NOT an attempt to show current (fair)value.
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Impairment
If asset declines in value below its carryingvalue, it should be writtendown and a loss should betaken.
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Noncurrent Assets – Investments
Investments in other
companies’ stock or
bonds that will be
maintained for longer than the
coming year
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Noncurrent Assets – Investments in AffiliatesReporting depends on theextent of ownership.You may see Minority Interestbeing subtracted because theentire sub’s results were included, but reporting co.does not own 100%.
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Noncurrent Assets - Intangibles
Economic resources that lack physical
substance, such as
patents and copyrights.
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Noncurrent Assets - Intangibles
The equivalent of depreciation is used…it has another name when we referto Intangible assets – Amortization.
Valuation is Net Book Valueunless an impairment occurs.
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Noncurrent Assets – Intangibles -- Goodwill
Goodwill is the excess onecompany pays to acquireanother company beyondthe current market valueof the identifiable assetsof the acquired company.
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Noncurrent Assets – Intangibles - Goodwill
Goodwill was amortizeduntil July of 2001.Now an impairment testmust be used.
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Noncurrent Assets – Intangibles - Goodwill
Just how good isGoodwill?
Look at World.Com’srecent announcementregarding Goodwill.
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Another way to thinkof this issue is that a) allocating HISTORICAL COST andb) recording current VALUE are NOT compatible goals...
Relevance and Reliability
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Buckminster Fuller’s dictum
No such thing as a free lunchapplies to assets.
Assets - a key principle
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Balance Sheet: Current Liabilities
1. Accounts Payable
2. S. T. Borrowings
3. Accrued Expenses
4. Taxes Payable
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Balance Sheet: NON-Current Liabilities
1. Long Term Borrowings2. Deferred Taxes
3. Leases
4. Other
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Long Term Liabilities
What you don’t see can hurt you…..issue of Capital versus operating leases.
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Long Term Liabilities
Far more dangerous and more creative is what Enron used….
Special Purpose Entities…. i.e. the company was essentially borrowing long-term but found ways to avoid showing that debt on the balance sheet.
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Shareholders’ Equity: The Owners’ Investment in a Company1.Capital Stock
CommonPreferred
2.Additional Paid in Capital3.Treasury Stock4.Retained Earnings5.Comprehensive Income
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What are likely results of using a variety of valuation methods on interpreting financial statements?
Meaning of the Balance Sheet
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Analyzing Financial Statements Ratio Analysis
– Examination of the relationships between pieces of information for a given accounting period
– Double entry accounting (using Dr and Cr) means that we should see relationships among various accounts in the balance sheet and the income statement.
– Cash Flow Statement and Equity statement are not generated directly by journal entries…so we tend not to use ratios as much to analyze them.
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LIQUIDITY RATIOS -.
Ability to satisfy short-term obligations
Quickratio =
Cash + Marketable securities + Acct. rec.
Current liabilities
Currentratio =
Current assets
Current liabilities
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Solvency Ratios -
Ability to repay long-term debt.
Total debt-to-total assets ratio
= Total assets
Long-term debt-to-equity ratio =
Long-term debt
Owners’ equity
Total Debt
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Solvency Ratios -
Ability to repay long-term debt.
Times-interest-earned ratio =
Interest Expense
Net income before income tax
Interest Expense+
Numerator called EBIT
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ASSET MGT RATIOShow efficient is use of assets?
Receivable turnover ratio =
Net credit sales for the period
Average receivable balance
Average receivable
collection period=
365 days
Receivable turnover ratio
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how efficient is use of assets?
Number of days’ inventory on
hand=
365 days
Inventory turnover ratio
Inventory turnover ratio =
Cost of goods sold
Average inventory
Asset Management Ratios - Cont’d .
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ASSET MGT Cont’d
how efficient is use of assets?
Noncurrent asset turnover
ratio
=Net sales
Average noncurrent asset balance
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Analyzing Financial StatementsBeyond ratios….. Trend Analysis
– Examination of a company’s numbers over time
Common-size Financial Statements– Expressing all amounts in the financial
statements as a percentage of a base number (Usually total assets or total sales)
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For Next Time…...
1.Do Homework2. Check out the
business press3. Select your company and industry if not yet done.
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What are likely results of using a variety of valuation methods on interpreting financial statements?
Meaning of the Balance Sheet
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Why do Assets Matter?
1. Valuations directly affect income.E.g. Accts Rec. allowance is Cr and Bad Debt Expense is Dr.
2.The non-current ones are significant for future costs.
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How to be Creative with?
Assets are one paletteupon which people canbecome creative…a) recognize revenues inadvance & a RECEIVABLEis on the Balance sheet -Halliburton Corporation.
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b) postpone costs….items that should be expensed
are capitalized (i.e.shown as a Non-current asset). What is
the effect onCurrent Income?
How to be Creative with?
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