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2-1
A FURTHER LOOK AT THE FINANCIAL STATEMENTS
Accounting, Fifth Edition
2
Fall 2015
2-2
The The ClassifiedClassified Balance Sheet Balance SheetThe The ClassifiedClassified Balance Sheet Balance Sheet
The B/S presents a snapshot at a point in time.
To improve understanding, companies group similar assets
and similar liabilities together in a specific order.
Standard Classifications
Assets S/EL
Common Stock & Retained Earnings
2-3
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
These are just the Assets. The Liabilities and Owner’s Equity are on the next slide.
2-4
Illustration 2-2
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
These are just the Liabilities and Owner’s Equity. Assets are on the previous slide.
2-5
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Assets that a company expects to convert to cash or use
up within one year or the operating cycle, whichever is
longer (the operating cycle is seldom used).
The operating cycle is the average time it takes from the
purchase of inventory to the collection of cash from
customers. If there’s no inventory (only a service is being
provided) then the operating cycle is much shorter.
Common types of current assets are (1) cash, (2) short
term investments, (3) receivables, (4) inventories, and (5)
prepaid expenses.
Current Assets
2-6
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Companies list current assets in the order they expect to convert them into cash. Note “in millions” means you have to add 6 zeros! It’s actually over 2 billion! These are all discussed in the NOTES to the F/S
Current Assets
$2,601,000,000
2-7
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Investments in stocks and bonds of other corporations that
are held for more than one year.
Long-term assets such as land or buildings that a company
is not currently using in its operating activities (you plan to
resell them for a profit at a later date).
Long-term notes receivable.
Long-Term Investments Long-term investments are often referred to simply as investments.
$90,266,000
Note only 3 zeros (in thousands) were added.
2-8
Property, Plant, and Equipment
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Long useful lives of more than 1 year
Currently used in operations (not as a long term investment)
Includes land, buildings, equipment, vehicles, and furniture.
Depreciation - allocating the cost of assets to a number of
years (more than 1 year).
Accumulated depreciation – the total amount of
depreciation expensed thus far in the asset’s life.
Land never wears out so we never depreciate land
Property, plant, and equipment is sometimes called Fixed Assets or Plant Assets or PPE
2-9
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Property, Plant, and Equipment
$991,816,000
2-10
Intangible Assets
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
LO 1
Assets that do not have physical substance.
Includes goodwill, patents, copyrights, and trademarks (covered more in Chapter 10)
Sometimes intangible assets are reportedunder a broader heading called “Other Assets.”
$92,806,000,000
2-11
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Obligations the company is to pay within the next year or the operating
cycle, whichever is longer.
Common examples are accounts payable, salaries and wages payable,
notes payable, interest payable, and income taxes payable.
Also included as current liabilities are current maturities of long-term
obligations (payments to be made within the next year on long-term
obligations; like a 30 year mortgage).
Current Liabilities
$127,143,000
2-12
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Obligations a company expects to pay after one year.
Include bonds payable, mortgages payable, long-term
notes payable, lease liabilities, and pension liabilities.
Long-Term Liabilities
$40,537,000,000
2-13
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
Stockholders’ Equity
Common stock - investments of assets into the business in
exchange for stock (the investments do not have to be cash).
“Retained” earnings - income retained (kept) for use in the
business (all the earnings since inception of the business less all
the dividends distributed back to shareholders). Dividends are
only shown on a Retained Earnings statement!
2-14
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
Ratio Analysis - A ratio expresses the mathematical relationship between two quantities and thus the relationship among selected F/S items
2-15
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
Profitability ratios measure the operating success of a company for a given period of time. Earnings per share (EPS) measures the NI earned on each share of common stock and is a profitability ratio!
Using the Income Statement
We can look at
the $ and %
changes between
years
Numbers in red and/or
(parens) mean a negative number
$ %
$576 1%
$(616) (1)%
$(40) (3)%
2-16
Using a
Classified
Balance Sheet
Note that Total Current Assets
exceed Total Current Liabilities in 2011 by
$1,810 million!
Liquidity is the ability to pay obligations expected within the next year or operating cycle. Best Buy is very liquid in 2011!
$17,849,000,000
2-17
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
Using a Classified Balance Sheet
One measure of liquidity is Working Capital: the excess of current assets over current liabilities that’s available to work with.
When working capital is positive, there is greater likelihood that the company will pay its liabilities.
Working Capital
Best Buy had working capital in 2011 of $1,810 million ($10,473 million - $8,663 million).
2-18
Using a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance Sheet
Liquidity ratios measure the short-term ability to pay maturing
obligations and to meet unexpected needs for cash. The Current
Ratio is an example of a liquidity ratio. It’s just like working capital
only calculated and expressed as a ratio.
For every dollar of current liabilities, Best Buy has $1.21 of current assets.
Liquidity Ratio
2-19
Using a Classified Balance Sheet
Solvency ratios measure the ability of the
company to survive over a long period of time.
Solvency is the ability to pay interest as it comes due and
repay the balance of a debt that’s due at its maturity.
For example, total debt to total assets is a solvency
ratio that measures the % of total financing provided by
creditors rather than stockholders $10,557/$17,849 =
59%!
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
2-20
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Qualities of Useful InformationAccording to the FASB, useful information should possess two
fundamental qualities, relevance and faithful representation.
2-21
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Enhancing Qualities
Comparability results when
different companies use the same
accounting principles.
Consistency means that a company uses the same accounting
principles and methods from year to year.
Information is verifiable if we are able to prove that it is free from error.
For accounting information to be relevant, it must be timely.
Information has the quality of
understandabilityif it is presented in a clear and concise
fashion.
Qualities of Useful Information
2-22
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Assumptions in Financial Reporting
Monetary UnitPeriodicity
Economic Entity
Requires that only those things that can
be expressed in $ money are included in
the accounting records.
States that every economic entity can be
separately identified (from personal
transactions) and accounted for.
States that the life of a business can be
divided into artificial time periods.
2-23
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Two More Assumptions in Financial Reporting
Going Concern Accrual-Basis
Transactions are recorded in the
periods in which the events occur.
The business will remain in operation for the foreseeable
future.
2-24
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Principles in Financial Reporting
Measurement Principles
Cost Fair Value Full disclosure
Also called the historical cost
principle, dictates that companies record assets at
their cost (not what they think it’s
worth)
Indicates that assets and
liabilities should be reported at fair value (the price
received to sell an asset or settle
a liability).
Requires that companies disclose all circumstancesand events that would make a
difference to users (provided in the F/S
and the notes).
2-25
Financial Reports ConceptsFinancial Reports ConceptsFinancial Reports ConceptsFinancial Reports Concepts
Constraints in Financial Reporting
Materiality Constraint
An item is material when its size makes it likely to influence the decision of an
investor or creditor.
Cost Constraint
Accounting standard-setters weigh the cost that companies will incur to provide the
information against the benefit thatfinancial statement users will gain.
2-26
Comparability
Going concern
Materiality
LO 7 Discuss financial reporting concepts.
The following items guide the FASB when it creates accounting standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption
Match each item above with a description below.
1. Ability to easily evaluate one company’s results relative to another’s.
2. Belief that a company will continue to operate for the foreseeable future.
3. The judgment concerning whether an item is large enough to matter to decision-makers.
2-27
Full disclosure
Periodicity
Relevance
LO 7 Discuss financial reporting concepts.
Match each item above with a description below.
4. The reporting of all information that would make a difference to financial statement users.
5. The practice of preparing financial statements at regular intervals.
6. The quality of information that indicates the information makes a difference in a decision.
The following items guide the FASB when it creates accounting standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption
2-28
Historical cost
Consistency
Economic entity
LO 7 Discuss financial reporting concepts.
Match each item above with a description below.
7. Belief that items should be reported on the balance sheet at the price that was paid to acquire the item.
8. A company’s use of the same accounting principles and methods from year to year.
9. Tracing accounting events to particular companies.
The following items guide the FASB when it creates accounting standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption
2-29
Faithful representation
Monetary unit
LO 7 Discuss financial reporting concepts.
Match each item above with a description below.
10. The desire to minimize errors and bias in financial statements.
11. Reporting only those things that can be measured in dollars.
The following items guide the FASB when it creates accounting standards.
Relevance Periodicity assumption
Faithful representation Going concern assumption
Comparability Historical cost principle
Consistency Full disclosure principle
Monetary unit assumption Materiality
Economic entity assumption
2-30
CL Salaries and wages payable LTI Investment in real estate
NA Service revenue PPE Equipment
CL Interest payable PPE Accumulated depreciation
IA Goodwill CA Debt investments (short-term)
NA Depreciation expense SE Retained earnings
LTL Mortgage payable CL Unearned service revenue
(due in 3 years)
Match each of the items to its proper balance sheet classification,
shown below. If the item would not appear on a balance sheet, use “NA.”
Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Long-term liabilities (LTL)
Property, plant, and equipment (PPE) Stockholders’ equity (SE)
Intangible assets (IA)
Solution
LO 1
What accounts would you need to calculate the Current Ratio?
2-31
What is the primary criterion by which accounting information
can be judged?
a. Consistency.
b. Predictive value.
c. Usefulness for decision making.
d. Comparability.
Review Question
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
LO 7 Discuss financial reporting concepts.
2-32
Cash, and other resources that are reasonably expected to
be realized in cash or sold or consumed in the business
within one year or the operating cycle, are called:
a. Current assets.
b. Intangible assets.
c. Long-term investments.
d. Property, plant, and equipment.
Review Question
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
LO 1 Identify the sections of a classified balance sheet.
2-33
Patents and copyrights are
a. Current assets.
b. Intangible assets.
c. Long-term investments.
d. Property, plant, and equipment.
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
LO 1 Identify the sections of a classified balance sheet.
Review Question
2-34
Which of the following is not a long-term liability?
a. Bonds payable.
b. Current maturities of long-term debt.
c. Long-term notes payable.
d. Mortgages payable.
The Classified Balance SheetThe Classified Balance SheetThe Classified Balance SheetThe Classified Balance Sheet
LO 1 Identify the sections of a classified balance sheet.
Review Question
2-35
The balance in retained earnings is not affected by:
a. net income
b. net loss
c. issuance of common stock
d. dividends
Review Question
LO 3 Explain the relationship between a retained earnings statement and a statement of stockholders’ equity.
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
2-36
Generally accepted accounting principles (GAAP) are:
a. a set of standards and rules that are recognized as a
general guide for financial reporting.
b. usually established by the Internal Revenue Service.
c. the guidelines used to resolve ethical dilemmas.
d. fundamental truths that can be derived from the laws
of nature.
Review Question
LO 6 Explain the meaning of generally accepted accounting principles.
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts