Download - Chapter 10 PowerPoint file
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Chapter 10: The Balance Sheet
Linking the balance sheet and income statement
Evolving definitions
Asset valuation
Liabilities and owners’ equities
Hybrid securities
Derivatives
Balance sheet classification issues
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Two Types of Relationships between Balance Sheet & Income Statement
ArticulatedThe two statements are mathematically linkedNet income is equal to the change in owners’ equity for a period, assuming no capital transactions or prior period adjustments
NonarticulatedThe two statements are independently definedThe relationship between the balance sheet and the income statement is severed
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Owners’ Equity
ContributedCapital
UnrealizedCapital
Adjustments
RetainedEarnings
OtherContributed
Capital
LegalCapital
IncomeStatementAccounts
PriorPeriod
Adjustments
Dividends
DR CR
Assets – Liabilities =
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Debits Credits
GainsRevenues
Ordinary Extraordinary
LossesExpenses
Ordinary Extraordinary
Income Statement Accounts
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Accounting Classification System
Rather simple
Complex transactions do not always fit neatly into one of the categories
Surprisingly, current accounting classification system is virtually unchanged since Pacioli’s time
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Articulated System Alternatives
Revenue-Expense approachConcerned with the definition, recognition, and measurement of incomeResult is that balance sheet contains assets, liabilities and ambiguous debits and credits called deferred charges and deferred credits
Asset-Liability approachSFAC No. 6 defines comprehensive income as the change in the firm’s net assets from nonowner sourcesFocuses on the measurement of net assets
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Definitions: Assets
Something represented by a debit balance that is or would be properly carried forward upon a closing of books of account according to the rules or principles of accounting ... Economic resources of an enterprise that are recognized and measured in conformity with generally accepted accounting principles. Assets also include certain deferred charges... Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
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Asset Definition Trend
Definitions of assets have evolved from a narrow legal orientation to a broader concept of economic resources.
As the definition has broadened, the boundary around what is and what is not an asset has become hazy and ambiguous.
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Executory Contracts: Assets?
a contract unperformed by both parties.
A long-standing problem in accounting has been the question of how to account (if at all) for mutually unperformed executory contracts.
traditional accounting view is that no recognition is required in financial statements because a binding exchange has not yet occurred. The contract is prospective.
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Recognition and Measurement
Assets and liabilities generally are initially recorded on the basis of events in which the enterprise acquires resources from other entities or incurs obligations to other entities.
The assets and liabilities are measured by the exchange prices at which the transfers take place.
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Assets
Initially recognized when the transaction transferring control occursAt this point in time, a potential exists for future economic benefits Measured at the market value (exchange price) of the consideration exchanged or sacrificed to acquire the assets and place them in operating condition.
called historical acquisition costhowever, an asset should not be recorded in an amount greater than its cash equivalent purchase price.
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Asset Valuation: A Lack of Additivity
original acquisition cost (historical cost)
historical cost less cumulative charges to income (book value)
replacement cost
selling prices
net realizable value
net realizable value less normal markups
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Summary of Asset Measurement
Receivables Approximate net realizable value
Investments...APB 115Amortized historical cost or fair value
Investments...APB 18Unique accounting attribute(equity accounting)
InventoriesCost, replacement cost, NRVor NRV less mark-up
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Summary of Asset Measurement
Self-constructed assetsFull-absorption for inventory;capitalize interest for noninventory
Assets subject todepreciation or depletion
Unique accounting attribute(book value)
Nonmonetary exchangesOf similar assets
Book value of old asset plus cash
Intangible assetsUnique accounting attribute(book value)
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Summary of Asset Measurement
Deferred chargesUnique accounting attribute(book value)
Restructured receivables...modification of terms
Newly restructured future cash inflows discounted at original rate
Impaired assetsFair value if less than carryingvalue, assuming...
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Definition: Liabilities
... not only items which constitute liabilities in the popular sense of debts or obligations ...but also credit balances to be accounted for which do not involve a debtor and creditor relation
economic obligations of an enterprise recognized and measured in conformity with GAAP
probable future sacrifices of economic benefits
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Definition: Owners’ Equity (OE)
The owners’ residual interest in the net assets of the firm
Two types of owners’ equity transactions
Capital
Income-related
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Definition: Hybrid Securities
Redeemable preferred stockTrust preferred stock
Company sells preferred stock to subsidiarySubsidiary sells bonds to parentParent takes interest tax deduction and eliminates debt in consolidation process
Securitizations involves the sale by a firm (called the transferor) of an asset or group of assets to another firm (called the transferee)is to keep debt off of its balance sheet
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Definition: Derivatives
Financial instruments whose value is based upon other financial instruments, stock indexes or interest rates, or interest rate indexes
Two typesForward-based derivatives
Options-based derivatives
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Types of Derivatives
Forward-based derivatives arise between two parties where one party will realize a gain and the other party will realize a loss due to a change in value of the factor underlying the instrument.
Option holders pay a specific “up front” price that gives them the right to buy (“call”) or sell (“put”) a specific quantity at a specific price of a standard commodity or a financial or equity instrument.
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Balance Sheet Classification Issues
Current-noncurrent approach gives only a crude indication of a firm’s liquidity
There are five distinctly different types of accounting liabilities:
contractual,
constructive,
equitable,
contingent,
and deferred charges
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Chapter 10: The Balance Sheet
Linking the balance sheet and income statement
Evolving definitions
Asset valuation
Liabilities and owners’ equities
Hybrid securities
Derivatives
Balance sheet classification issues