2-1 a further look at the financial statements accounting, fifth edition 2 fall 2015

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

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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.

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Illustration 2-2


These are just the Liabilities and Owner’s Equity. Assets are on the previous slide.

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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

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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

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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.

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Property, Plant, and Equipment


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

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Property, Plant, and Equipment

$991,816,000

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Intangible Assets


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

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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

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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

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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!

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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

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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)%

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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

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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).

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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

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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%!


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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.

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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

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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.

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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.

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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).

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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.

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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.

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Full disclosure

Periodicity

Relevance



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.








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Historical cost

Consistency

Economic entity



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.








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Faithful representation

Monetary unit



10. The desire to minimize errors and bias in financial statements.

11. Reporting only those things that can be measured in dollars.








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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?

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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


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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


LO 1 Identify the sections of a classified balance sheet.

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Patents and copyrights are

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.



Review Question

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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.



Review Question

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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.


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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

2-1 a further look at the financial statements accounting, fifth edition 2 fall 2015

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